Financial Crisis
Suppose that banks are less able to raise funds and so lend less. Consequently, because people and households are less able to borrow, they spend less at any given price level than they would otherwise. The crisis is persistent so lending should remain depressed for some time.
-Refer to Financial Crisis. Suppose the economy reaches long-run equilibrium without the Fed responding. Now suppose the financial crisis ends and the ability of banks to lend returns to normal. In which case is the price level lower compared to its value prior to the crisis?
A) both after the economy reaches long-run equilibrium during the crisis and in the long-run equilibrium after the crisis is over
B) after the economy reaches long-run equilibrium during the crisis but not in the long-run equilibrium after the crisis is over
C) in the long-run equilibrium after the crisis is over but not after the economy reaches long-run equilibrium during the crisis
D) neither after the economy reaches long-run equilibrium during the crisis nor in the long-run equilibrium after the crisis is over

Question

Quizplus · Accepted Answer

During the crisis, reduced spending leads to a lower price level in long-run equilibrium. Once the crisis ends and lending returns to normal, spending increases, and the price level returns to its pre-crisis level.

Financial Crisis Suppose That Banks Are Less Able to Raise Funds and Funds