A change in the inflation rate will
A)not affect the demand for real balances.
B)affect the demand for real balances through its effect on real output.
C)affect the demand for real balances through its effect on the payments system.
D)affect the demand for real balances through its effect on the nominal market interest rate.

Question

Quizplus · Accepted Answer

A change in the inflation rate will affect the demand for real balances through its effect on the nominal market interest rate. When the inflation rate increases, the nominal interest rate increases, which decreases the demand for real balances because people find it less attractive to hold money in accounts with low interest rates. Conversely, when the inflation rate decreases, the nominal interest rate decreases, which increases the demand for real balances because people find it more attractive to hold money in accounts with higher interest rates.

A Change in the Inflation Rate Will