The Keynesian mechanism through which monetary policy affects the price level, real GDP, and employment depends on the impact of the:
A) interest rate on savings.
B) inflation on investment.
C) interest rate on investment.
D) interest rate on bond prices.

Question

Quizplus · Accepted Answer

According to Keynesian economics, the central bank can affect the economy by manipulating the interest rates, particularly the short-term interest rates, with the help of monetary policy. The interest rate affects the level of investment in the economy. When the central bank reduces the interest rate, firms can borrow money at a lower cost, making investment cheaper, and causing a rise in aggregate demand. As a result, the level of real GDP and employment increases, and the price level rises due to increased demand for goods and services. On the other hand, when the central bank increases the interest rate, investment becomes more expensive, causing a fall in aggregate demand, which leads to a decrease in real GDP and employment, and a fall in the price level due to decreased demand for goods and services.

The Keynesian Mechanism Through Which Monetary Policy Affects the Price