In the IS/MP framework, when the Fed ________ the federal funds rate in the aftermath of the decline in housing prices, the financial friction gave rise to a(n) ________ in the real interest rate, which caused a(n) ________.
A) lowered; increase; deeper recession
B) raised; decline; commodity bubble
C) lowered; decline; expansion
D) held constant; economic "settling"; disinflation
E) lowered; decrease; deeper recession

Question

Quizplus · Accepted Answer

According to the IS/MP framework, when the Fed lowers the federal funds rate, it should lead to a decrease in the real interest rate, which would stimulate economic activity and lead to an expansion. However, in the aftermath of the decline in housing prices, financial frictions caused the real interest rate to increase instead, leading to a deeper recession. Therefore, the best choice is A, which reflects this scenario of the Fed lowering rates but the real interest rate increasing and leading to a deeper recession.

In the IS/MP Framework, When the Fed ________ the Federal