True or False Suppose that the economy has experienced a rec

True or False: Suppose that the economy has experienced a recession, resulting in real GDP being below its natural level. Also suppose that the natural level of real GDP for the US grows at 2.5% per year. Then, to achieve complete recovery real GDP must grow at more than 2.5% for a period of time. Explain your reasoning.

Solution

True

Explanation: To achieve complete recovery real GDP must grow at more than 2.5% for a period of time. This is because of the base effect. Due to the recession, the real GDP becomes lower than the natural level of GDP. Now, the natural level of GDP would be growing at 2.5% every year in the absence of the recession. The recession results in a lower GDP base. So, it needs to grow at a higher % than the natural rate of growth in order to compensate for the recession.