According to the interest-rate effect, higher prices
A) increase the value of money holdings which reduces consumption and investment spending.
B) decrease the value of money which decreases consumption and investment spending.
C) lower the real quantity of money, which causes interest rates to rise and investment to fall.
D) lead to higher interest rates which reduces investment spending.

Question

Quizplus · Accepted Answer

According to the interest-rate effect, higher prices lead to higher interest rates. This is because higher prices mean that more money is required to purchase goods and services, which leads to a decrease in the real value of money. As a result, people and firms demand more money in order to maintain their desired level of real money balances, which lowers the supply of loanable funds and raises the interest rate. Higher interest rates in turn discourage investment spending, as the cost of borrowing increases. Therefore, choice D is the best answer.

According to the Interest-Rate Effect, Higher Prices