The long-run self-correcting mechanism that eliminates recessionary and expansionary output gaps in the economy assumes
A) only that the growth in wages and production costs adjusts over time.
B) only that the inflation rate adjusts over time.
C) only that the central bank adjusts the real interest rate over time in response to changes in the inflation rate.
D) only that aggregate demand and actual output (Y)adjust towards potential output (Y*)over time.
E) that the growth in wages and production costs,the inflation rate,the real interest rate,and aggregate demand and output all adjust over timE.

Question

Quizplus · Accepted Answer

The long-run self-correcting mechanism assumes that all of the factors listed in option E adjust over time to eliminate recessionary and expansionary output gaps. As wages and production costs increase, the inflation rate also increases, which leads to a rise in the real interest rate. The higher interest rate reduces aggregate demand, which reduces output towards potential output. Therefore, all the factors listed in option E work together to bring the economy towards equilibrium in the long run.

The Long-Run Self-Correcting Mechanism That Eliminates Recessionary and Expansionary Output