An economy is experiencing a severe recession. To encourage economic activity, the central bank has set its primary policy interest rate to 0%. However, recent surveys indicate that consumers and businesses expect the overall price level to decrease by 2% over the coming year. Which of the following statements best describes the economic situation and the challenge for the central bank's policy?

Real Interest Rates in a Deflationary Environment

Consider an economy where the central bank's policy interest rate is fixed at 0%. If consumers and firms begin to expect a 2% annual decrease in the general price level, the real cost of borrowing will decrease, thereby stimulating investment and consumption.