Suppose the public expects a 7 percent inflation rate, and both the money supply and money demand grow at 7 percent a year. Suddenly the Federal Reserve unexpectedly allows the money growth rate to be 4 percent. In the short run, we expect that investment spending by firms will ________ and consumer durable spending will ________.
A) decrease; decrease
B) increase; decrease
C) decrease; increase
D) increase; increase

Question

Quizplus · Accepted Answer

When the Federal Reserve unexpectedly allows the money growth rate to be 4 percent, it will decrease the money supply and result in an increase in interest rates. This, in turn, will decrease investment spending by firms due to higher borrowing costs, and consumer durable spending will also decrease due to higher interest rates on loans. Therefore, the correct choice is A.

Suppose the Public Expects a 7 Percent Inflation Rate, and Both