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The whole story is given in the past. Is the sentence in the middle of the story "But why did she wish to do it now?" grammmatically correct? Is it correct to use the Past Simple tense with the adverb "now" talking about past events?

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Do you mean as in OP had come across this usage before. Now he decided to establish whether it was really grammatical.? – FumbleFingers Nov 19 '11 at 14:33

Yes, it is correct. Check out definition #4 here:

At this point in the series of events; then: The ship was now listing to port.

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Now can be used in this way in stories to describe a new event.

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