(3) In reality, serious deflation occurred, people started to hoard to liquidity
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Question
(3) In reality, serious deflation occurred, people started to hoard to liquidity trap. was the most critical monetary factor leading to deflation? Why deflation in modern time is rare? Clearly government failed to maintain stable price level. Wha copper coins, leading (4) When liquidity trap occurred, is it appropriate to assume constant velocity of money? Explain. And If not, would the velocity increase or decrease, what would be the impact on price level? (5) When Wudi fought a series of battles with militarily strong invaders and drove them far away from the border, the deflation process was reversed. Was the price level change caused by monetary policy? What would happen to liquidity trap?Explanation / Answer
3.
The most critical monetary factor was the extremely low interest rate that made people to believe that interest rates will increase in the future. It made them to save more and spend less. It caused to reduce the aggregate demand and prices came down.Here, people think the lower interest rate of today, will lead to higher interest rate in the near future. It further leads prices to come down. It eventually led to the deflation in the economy. Occurrence of deflation, takes place rarely because prices as well as wages are sticky in short run. It means that wages will not decrease even if the unemployment increases. So, it makes prices to be the same even if the demand decreases. Besides, monetary policy is complemented by the fiscal policy that aims to encourage he aggregate demand. It also prevents the happening of deflation in the economy.
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