Question

Why does the​ self-correcting mechanism stop working when the policy rate hits the zero lower​ bound? A. The​ self-correcting mechanism stops working because the rising inflation produced by a negative output gap produces lower rather than higher real interest rates when the policy rate hits the zero lower​ bound, and this decrease depresses planned spending and further widens the output gap. B. The​ self-correcting mechanism stops working because the falling inflation produced by a negative output gap produces lower rather than higher real interest rates when the policy rate hits the zero lower​ bound, and this decrease depresses saving and investment and therefore further widens the output gap. C. The​ self-correcting mechanism stops working because the falling inflation produced by a negative output gap produces higher rather than lower real interest rates when the policy rate hits the zero lower​ bound, and this increase depresses planned spending and further widens the output gap. D. The​ self-correcting mechanism stops working because the rising inflation produced by a positive output gap produces lower rather than higher real interest rates when the policy rate hits the zero lower​ bound, and this decrease enhances planned spending and further widens the output gap.

Answer 1

Answer:

C. The​ self-correcting mechanism stops working because the falling inflation produced by a negative output gap produces higher rather than lower real interest rates when the policy rate hits the zero lower​ bound, and this increase depresses planned spending and further widens the output gap.          

Explanation:

The zero lower bound is the problem in macroeconomics when the nominal interest rate for short term is near to zero or at zero. It is the limit to which the interest rate can be lowered to but not any further.

The self correcting mechanism in economic imbalances stops working when the policy rate hits the zero bound of lower limit because the fall in the money value results in the higher real rate of interest than lower real interest rates. As a result, output gap widens.

Hence the answer is ---

C. The​ self-correcting mechanism stops working because the falling inflation produced by a negative output gap produces higher rather than lower real interest rates when the policy rate hits the zero lower​ bound, and this increase depresses planned spending and further widens the output gap.