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