The effect of a decline in the money supply on the economy differs from the effect of a decline in the willingness of banks to lend in that a decline in the money supply will lead to
A)a decline in output, whereas a decline in the willingness of banks to lend will lead to an increase in output.
B)an increase in the price level, whereas a decline in the willingness of banks to lend will lead to a decrease in the price level.
C)an increase in the real interest rate, whereas a decline in the willingness of banks to lend will lead to a decrease in the real interest rate.
D)a decrease in the price level, whereas a decline in the willingness of banks to lend will lead to an increase in the price level.

Question

Quizplus · Accepted Answer

A decline in the money supply will lead to a decrease in spending, which in turn will lead to a decrease in output. This will also lead to an increase in the real interest rate as there are fewer funds available for borrowing. On the other hand, a decline in the willingness of banks to lend will lead to a decrease in borrowing and spending, which will also lead to a decrease in output. However, this will also lead to a decrease in the real interest rate as banks will lower interest rates to encourage borrowing. Therefore, the statements in choices A, B, and D are incorrect.

The Effect of a Decline in the Money Supply on the Economy