If the Fed wants to permanently lower interest rates,then it should lower the rate of money growth if
A) there is fast adjustment of expected inflation.
B) there is slow adjustment of expected inflation.
C) the liquidity effect is smaller than the expected inflation effect.
D) the liquidity effect is larger than the other effects.

Question

Quizplus · Accepted Answer

The correct choice is C because if the liquidity effect (the immediate impact of an increase in the money supply leading to lower interest rates) is smaller than the expected inflation effect (the anticipation of higher inflation leading to higher interest rates), then lowering the rate of money growth would help in permanently lowering interest rates. This is because the expected inflation effect, which puts upward pressure on interest rates, would be mitigated more significantly than the liquidity effect, which temporarily lowers interest rates.

If the Fed Wants to Permanently Lower Interest Rates,then It