Discuss how the zero lower bound on nominal interest rate

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Reference no: EM133461154

Questions: A closed economy is initially in a medium-run equilibrium:\ output is resting at potential output, the actual and expected inflation rates are 33 and inflation expectations are anchored at ??¯=3

(a) Using the IS-LM-PC model, draw a sketch of the initial equilibrium. Be sure to discuss the lower bounds for the nominal and real interest rates.

(b) Now suppose due to a fall in business confidence, investment spending significantly falls. Describe the process in the short run. How does the short-run equilibrium output and inflation compare to their counterparts in the initial medium-run equilibrium if the central bank does not change the interest rate?

(d) Discuss how the zero lower bound on the nominal interest rate may hinder the medium-term correction and potentially cause a deflationary spiral.

Reference no: EM133461154

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