5 The following diagram shows an economy where monetary poli

5. The following diagram shows an economy where monetary policy has reached the lower zero bound (LZB). AD (a) the In the ZLB the \"self-correcting\" mechanism of the economy will cause the potential level of output. curve to shift moving the economy (b) to fall Expansionary fiscal policy is more effective when the economy is below the ZLB than when it is above the ZLB since it causes the resuing in amultiplier e

Solution

a) In the ZLB, the self correcting mechanism of the economy will cause the aggregate demand curve to shift rightwards, moving the economy towards the potential level of output.

b) Expansionary fiscal policy is more effective when the economy is below the ZLB then when it is above the ZLB since it causes the interest rate to fall, resulting in a increased multiplier effect.