Suppose there is a simultaneous tax increase and open market purchase of bonds. Which of the following must occur as a result of this?

Question

Quizplus · Accepted Answer

Both the open market purchase of bonds and the tax increase work to decrease aggregate demand. However, the open market purchase of bonds leads to an increase in the money supply and thus a decrease in interest rates. Therefore, the decrease in interest rates resulting from the open market purchase of bonds would offset the increase in interest rates resulting from the decrease in demand due to the tax increase. Overall, the interest rate would decrease, which is the opposite of what would happen in option E.

Suppose There Is a Simultaneous Tax Increase and Open Market