A central bank governor makes the following statement: "To ensure robust long-term prosperity, our new permanent policy will be to hold the real interest rate at 0.5%, which is significantly below the rate that has historically balanced our economy. This will guarantee higher investment and output indefinitely." Assuming the underlying productive capacity (the supply side) of the economy does not change, what is the most significant flaw in this plan?
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Central Bank's Short-Run Control over the Real Interest Rate
A central bank governor makes the following statement: "To ensure robust long-term prosperity, our new permanent policy will be to hold the real interest rate at 0.5%, which is significantly below the rate that has historically balanced our economy. This will guarantee higher investment and output indefinitely." Assuming the underlying productive capacity (the supply side) of the economy does not change, what is the most significant flaw in this plan?
Long-Run Monetary Policy Consequences
The Limits of Long-Run Monetary Policy
In the long run, a central bank can permanently stimulate economic output above its equilibrium level by consistently setting its policy rate to maintain a real interest rate below the level required for supply-side equilibrium.