Many borrowers defaulted on subprime mortgages ultimately disrupting financial markets by August 2007.Which of the following is a likely result of this increase in financial frictions?
A)The AD curve likely shifted left which caused a negative output gap.
B)The AD curve likely shifted left which caused a positive inflation gap.
C)The AD curve likely shifted left which caused an upward movement along the MP curve to a higher general equilibrium interest rate.
D)The AD curve likely did not shift.
E)none of the above

Question

Quizplus · Accepted Answer

The increase in financial frictions due to defaults on subprime mortgages would likely reduce overall spending in the economy, leading to a leftward shift in the Aggregate Demand (AD) curve. This shift would result in a negative output gap, where actual output is less than potential output, reflecting a downturn or recessionary condition in the economy.

Many Borrowers Defaulted on Subprime Mortgages Ultimately Disrupting Financial Markets