Chaletland should interest rates during a recession and interest rates during an economic boom in order to maintain long-run equilibrium.
a) increase; increase
b) decrease; decrease
c) decrease; increase
d) increase; decrease

The correct answer is option c.

Explanation:

During the recession, production and investment get reduced. A decrease in the interest rate will reduce the cost of borrowing. This will make borrowing funds for investment cheaper.  

As a result, investment spending will increase. As firms invest more they will need more workers. So production and employment will increase as well.  

During inflation, there is increased demand and a higher price level. An increase in the interest rate will increase the cost of borrowing. This will make borrowing expensive. Investment spending will decline. This will cause the aggregate demand to reach to its long-run equilibrium level.

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