Suppose a contractionary monetary policy raises nominal interest rates. If this is the case, it follows that the contractionary monetary policy must have:

Question

Quizplus · Accepted Answer

A contractionary monetary policy typically leads to higher nominal interest rates primarily through its effect on real interest rates. By reducing the money supply or increasing the policy rate, the central bank makes borrowing more expensive, which directly increases real interest rates. While this policy might also influence inflation expectations, the primary mechanism is through real rates, hence the correct answer is that it increases real interest rates more than it reduces expected inflation.

Suppose a Contractionary Monetary Policy Raises Nominal Interest Rates