Two countries are facing a severe economic recession. Both of their central banks determine that to stimulate economic activity, they need to achieve a target real interest rate of -3%. Country A has historically maintained an average inflation rate of 1%. Country B has historically maintained an average inflation rate of 4%. Assuming both central banks cut their nominal policy interest rates as low as they can go (to zero), which of the following outcomes is most likely?
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Central Bank Policy Flexibility
Central Bank Policy Dilemma
If a central bank is constrained by the fact that it cannot set its policy interest rate below zero, a higher prevailing rate of inflation makes it more difficult for the bank to achieve a negative real interest rate to stimulate the economy.
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