Aggregate demand has fallen so that GDP is below its potential. Prices begin to fall. The next step in describing the dynamics of the effect of a reduction in investment is
A) a return of investment to its original level in direct response to the falling prices.
B) a decline in the interest rate to maintain equality of supply and demand in the money market.
C) a decline in the real) supply of money, caused by the falling prices.
D) an increase in the demand for money as people respond to the expectation of lower inflation.
E) none of the above.

Question

Quizplus · Accepted Answer

When aggregate demand falls and GDP is below its potential, leading to falling prices, one of the next steps in the dynamics is a decline in the interest rate. This occurs as central banks or monetary authorities adjust policy rates to stimulate the economy, or naturally as the demand for money falls with lower investment and spending, both aiming to maintain equality of supply and demand in the money market. Lower interest rates make borrowing cheaper, which can encourage investment and spending, helping to push the economy back towards its potential output.

Aggregate Demand Has Fallen So That GDP Is Below Its