Housing prices in the United States fell sharply in 2007 and 2008, contributing to a severe recession as the AD curve shifted leftward. The ordinary AS/AD model would predict that falling short-run aggregate supply would bring deflation and move the economy back to potential output. Which of the following describes the impact of dynamic feedback effects on this return to potential output?
A. Falling house prices could cause people to buy more houses than they really need, creating a further crisis as another wave of foreclosures and bankruptcies occurs.
B. The deflation will be counteracted by increases in the money supply from the Federal Reserve, preventing the price adjustment and keeping the economy below potential output.
C. Expectations that prices might fall further could cause people to reduce spending, shifting the AD curve further to the left.
D. As the SAS curve shifts downward, firms respond by increasing their investment in capital equipment, but only rehired a few of the laid-off workers, therefore, employment did not return to normal.
Answer: C
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A. nominal GDP remains constant. B. the velocity of money has to increase. C. the velocity of money has to decrease. D. the real GDP had to rise.