Suppose a negative aggregate demand shock causes short-run output to drop to -1%

Question

Suppose a negative aggregate demand shock causes short-run output to drop to -1%. To stimulate investment and bring the economy back to potential output the interest rate decreases by 1 percentage point. However, as a result investment increases more than expected and short-run output reaches 1%. This result could be caused by:

a. An increase in the consumption share of potential output

b. An increase in the government purchases share of potential output

c. A decrease in the import share of potential output

d.The presence of a consumption multiplier

e. All of these are correct

Explanation / Answer

Solution: All of these are correct

Explanation: When economy is facing real negative economic shock, the Fed must make its policy choice between too high of an inflation rate and too low of a growth rate, thus all the options are correct

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