Suppose the public expects a 7 percent inflation rate, and both the money supply and money demand grow at 7 percent a year. The Federal Reserve decides to keep the the money growth rate to be 7 percent. In the short run, we expect that investment spending by firms will ________ and consumer durable spending will ________.
A) increase; decrease
B) decrease; increase
C) increase; increase
D) None of the above; there will be no change in the level of investment spending by firms and consumer durable spending by households.

Question

Quizplus · Accepted Answer

If the money supply and money demand grow at the same rate as the expected inflation rate, and the Federal Reserve decides to keep money growth rate to be 7 percent, there will be no change in the level of investment spending by firms and consumer durable spending by households in the short run. This is because the growth rate of money supply and money demand cancel out inflation expectations in the short run, leaving the real interest rate and real income unchanged. Therefore, option D is correct.

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