In a world of rational expectations,
A) an anticipated increase in money supply leads immediately to higher nominal interest rates.
B) an anticipated increase in money supply leads immediately to lower nominal interest rates.
C) an unanticipated increase in money supply leads immediately to higher nominal interest rates.
D) an unanticipated decrease in money supply leads immediately to lower nominal interest rates.

Question

Quizplus · Accepted Answer

In a world of rational expectations, an anticipated increase in money supply is expected to lead to inflation. As a result, lenders demand higher nominal interest rates to compensate for the anticipated decrease in the purchasing power of money. This is because they expect that the value of the money when it is paid back in the future will be less due to inflation.

In a World of Rational Expectations