Question
Hi. Can you please explain the teachers answer to this question? Is it possible that the economy will enter a deflation trap in 2019? Under
Hi. Can you please explain the teachers answer to this question?
Is it possible that the economy will enter a deflation trap in 2019? Under what circumstances?
"A deflation trap is a situation in which deflation increases the real interest rate, which leads to lower economic activity, which leads to further deflation, a further increase in the real rate etc. This may happen when the nominal interest rate hits the zero lower bound, so that the central bank cannot lower the nominal rate enough to achieve a decrease in the real interest rate. In d), the central bank needs to decrease the nominal rate in order to decrease the real rate. With an inflation rate of -3% in 2019, this means that the nominal rate needs to be decreased by more than 3% in order to achieve a decrease in the real rate ( = ). So if the nominal rate was lower than 3% at the start of 2019, the central bank cannot achieve its goal, and the economy might get into a deflation trap."
In particular, why would the nominal rate need to be more that 3&? can you show how to know that?
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