Using the liquidity preference framework, show what happens to interest rates during a business cycle recession.

Using the liquidity preference framework, show what happens to interest rates during a business cycle recession.

Answer: During a business cycle recession, income will fall. This causes the money demand curve to shift to the left. The resulting equilibrium will be at a lower interest rate.

Using the liquidity preference framework, what will happen to interest rates if the Fed increases the money supply?

Using the liquidity preference framework, what will happen to interest rates if the Fed increases the money supply?

Answer: The Fed's actions shift the money supply curve to the right. The new equilibrium interest rate will be lower than it was previously.

If the liquidity effect is smaller than the other effects, and the adjustment to expected inflation is immediate, then the

If the liquidity effect is smaller than the other effects, and the adjustment to expected inflation is immediate, then the

A) interest rate will fall.
B) interest rate will rise.
C) interest rate will fall immediately below the initial level when the money supply grows.
D) interest rate will rise immediately above the initial level when the money supply grows.

Answer: D

If the liquidity effect is smaller than the other effects, and the adjustment to expected inflation is slow, then the

If the liquidity effect is smaller than the other effects, and the adjustment to expected inflation is slow, then the

A) interest rate will fall.
B) interest rate will rise.
C) interest rate will initially fall but eventually climb above the initial level in response to an increase in money growth.
D) interest rate will initially rise but eventually fall below the initial level in response to an increase in money growth.

Answer: C

Of the four effects on interest rates from an increase in the money supply, the initial effect is, generally, the

Of the four effects on interest rates from an increase in the money supply, the initial effect is, generally, the

A) income effect.
B) liquidity effect.
C) price level effect.
D) expected inflation effect.

Answer: B

Of the four effects on interest rates from an increase in the money supply, the one that works in the opposite direction of the other three is the

Of the four effects on interest rates from an increase in the money supply, the one that works in the opposite direction of the other three is the

A) liquidity effect.
B) income effect.
C) price level effect.
D) expected inflation effect.

Answer: A

Milton Friedman contends that it is entirely possible that when the money supply rises, interest rates may ________ if the ________ effect is more than offset by changes in income, the price level, and expected inflation.

Milton Friedman contends that it is entirely possible that when the money supply rises, interest rates may ________ if the ________ effect is more than offset by changes in income, the price level, and expected inflation.

A) fall; liquidity
B) fall; risk
C) rise; liquidity
D) rise; risk

Answer: C

If the Fed wants to permanently lower interest rates, then it should raise the rate of money growth if

If the Fed wants to permanently lower interest rates, then it should raise the rate of money growth if

A) there is fast adjustment of expected inflation.
B) there is slow adjustment of expected inflation.
C) the liquidity effect is smaller than the expected inflation effect.
D) the liquidity effect is larger than the other effects.

Answer: D

When the growth rate of the money supply is increased, interest rates will fall immediately if the liquidity effect is _________ than the other money supply effects and there is ________ adjustment of expected inflation.

When the growth rate of the money supply is increased, interest rates will fall immediately if the liquidity effect is _________ than the other money supply effects and there is ________ adjustment of expected inflation.

A) larger; fast
B) larger; slow
C) smaller; slow
D) smaller; fast

Answer: B

When the growth rate of the money supply increases, interest rates end up being permanently lower if

When the growth rate of the money supply increases, interest rates end up being permanently lower if

A) the liquidity effect is larger than the other effects.
B) there is fast adjustment of expected inflation.
C) there is slow adjustment of expected inflation.
D) the expected inflation effect is larger than the liquidity effect.

Answer: A

______ in the money supply creates excess demand for ________, causing interest rates to ________, everything else held constant.

______ in the money supply creates excess demand for ________, causing interest rates to ________, everything else held constant.

A) an increase; money; rise
B) an increase; bonds; fall
C) a decrease; bonds; rise
D) a decrease; money; fall

Answer: B

_____ in the money supply creates excess ________ money, causing interest rates to ________, everything else held constant.

_____ in the money supply creates excess ________ money, causing interest rates to ________, everything else held constant.

A) a decrease; demand for; rise
B) an increase; demand for; fall
C) an increase; supply of; rise
D) a decrease; supply of; fall

Answer: A

When the price level falls, the ________ curve for nominal money ________, and interest rates ________, everything else held constant.

When the price level falls, the ________ curve for nominal money ________, and interest rates ________, everything else held constant.

A) demand; decreases; fall
B) demand; increases; rise
C) supply; increases; rise
D) supply; decreases; fall

Answer: A

When the Fed ________ the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant.

When the Fed ________ the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant.

A) decreases; right; rises
B) increases; right; falls
C) decreases; left; falls
D) increases; left; rises

Answer: B

When the Fed decreases the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant.

When the Fed decreases the money stock, the money supply curve shifts to the ________ and the interest rate ________, everything else held constant.

A) right; rises
B) right; falls
C) left; falls
D) left; rises

Answer: D

Interest rates increased continuously during the 1970s. The most likely explanation is

Interest rates increased continuously during the 1970s. The most likely explanation is 

A) banking failures that reduced the money supply.
B) a rise in the level of income.
C) the repeated bouts of recession and expansion.
D) increasing expected rates of inflation.

Answer: D

In the liquidity preference framework, a one-time increase in the money supply results in a price level effect. The maximum impact of the price level effect on interest rates occurs

In the liquidity preference framework, a one-time increase in the money supply results in a price level effect. The maximum impact of the price level effect on interest rates occurs

A) at the moment the price level hits its peak (stops rising) because both the price level and expected inflation effects are at work.
B) immediately after the price level begins to rise, because both the price level and expected inflation effects are at work.
C) at the moment the expected inflation rate hits its peak.
D) at the moment the inflation rate hits it peak.

Answer: A

A decline in the expected inflation rate causes the demand for money to ________ and the demand curve to shift to the ________, everything else held constant.

A decline in the expected inflation rate causes the demand for money to ________ and the demand curve to shift to the ________, everything else held constant.

A) decrease; right
B) decrease; left
C) increase; right
D) increase; left

Answer: B

A rise in the price level causes the demand for money to ________ and the interest rate to ________, everything else held constant.

A rise in the price level causes the demand for money to ________ and the interest rate to ________, everything else held constant.

A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase

Answer: D

When the price level ________, the demand curve for money shifts to the ________ and the interest rate ________, everything else held constant.

When the price level ________, the demand curve for money shifts to the ________ and the interest rate ________, everything else held constant.

A) falls; left; falls
B) rises; right; falls
C) falls; left; rises
D) rises; right; rises

Answer: D