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Homework answers / question archive /  When the Federal Reserve increases the growth rate of the money supply, the income effect causes the interest rate to interest rate Continuing on the same train of thought, when the Fed decreases the growth rate of the money supply, the price level effect drives the interest rate while the expected inflation rate pushes the interest rate Suppose there is an increase in the growth rate of the money supply

 When the Federal Reserve increases the growth rate of the money supply, the income effect causes the interest rate to interest rate Continuing on the same train of thought, when the Fed decreases the growth rate of the money supply, the price level effect drives the interest rate while the expected inflation rate pushes the interest rate Suppose there is an increase in the growth rate of the money supply

Economics

 When the Federal Reserve increases the growth rate of the money supply, the income effect causes the interest rate to interest rate Continuing on the same train of thought, when the Fed decreases the growth rate of the money supply, the price level effect drives the interest rate while the expected inflation rate pushes the interest rate Suppose there is an increase in the growth rate of the money supply. If the liquidity effect is smaller than the income, price-level, and expected inflation effects, and if inflationary expectations adjust slowly, then in the short run, interest rates O A. become unpredictable. B. remain unchanged O C. fall OD. rise

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Ok, Let me help you reason the answers better. Let us take the question one-by-one: (see the red color text as explainatory from my side):

When the Federal Reserve increases the growth rate of money supply, the income effect causes the interest rate to RISE (because with increased disposable income, consumers will expand the aggregate demand in the country and to check the same Federal Reserve will have to increase the interest rates) while the liquidity effect drives the interest rates to FALL (because with enhanced liquidity people will agree to deposit their savings in bank even at lower rate of interest.)

Continuing on the same train of thought, when the Fed decreases the growth rate of money supply, the price level effect drives the interest rates FALL (because with reduced money supply there will be deflation in the economy and to correct the same or say to increase the demand in economy the Fed will lower the interest rates) while the expected inflation rate pushes the interest rate UPWARDS because inflationary pressure is always corrected by way of increasing the interest rates by Fed.

Suppose there is an increase in the growth rate of money supply, if the liquidity effect is smaller than the income, price level, and expected inflation effects, and if inflationary expectations adjust slowly, then in the short run, interest rates:

A. become unpredictable:Wrong answer because predictability is available when the information about so many parameters is available there.
B. remain unchanged this is the right answer. Because when inflationary expectations are adjusting slowly and also liquidity effect remains immaterial, then in the short run perspective the interest rates will remain stable.
C. fall Wrong answer because liquidity factor being smaller than other factors, interest rates in short run will change any way but not fall.
D. rise Wrong answer because had it been a long run perspective, this could have been the right answer. but in short run view, this is not done.