The long-run self-correcting mechanism that eliminates an expansionary output gap (Y Y*)in the economy assumes that
A) the growth in wages and production costs speed up over time.
B) the inflation rate decreases over time.
C) the central bank lowers the nominal interest rate by more than the fall in the inflation rate,so that the real interest rate decreases over time.
D) aggregate demand and actual output increase towards potential output over time.
E) the growth in wages and production costs slow down over timE.

Question

The long-run self-correcting mechanism that eliminates an expansionary output gap (Y > Y*)in the economy assumes that
A) the growth in wages and production costs speed up over time.
B) the inflation rate decreases over time.
C) the central bank lowers the nominal interest rate by more than the fall in the inflation rate,so that the real interest rate decreases over time.
D) aggregate demand and actual output increase towards potential output over time.
E) the growth in wages and production costs slow down over timE.

Quizplus · Accepted Answer

In the long run, an expansionary output gap leads to increased demand for labor, which causes wages and production costs to rise. This increase in costs reduces aggregate supply, moving the economy back towards potential output.

The Long-Run Self-Correcting Mechanism That Eliminates an Expansionary Output Gap