When the Fed unexpectedly increases the money supply, it will cause an increase in aggregate demand because
A) real interest rates will fall, stimulating business investment and consumer purchases.
B) the dollar will appreciate on the foreign exchange market, leading to a decrease in net exports.
C) lower interest rates will tend to decrease asset prices (for example, stock prices), which decreases wealth and, thereby, decreases current consumption.
D) the general level of prices will fall, which will increase the disposable income of households.

Question

Quizplus · Accepted Answer

When the Fed unexpectedly increases the money supply, it leads to a decrease in real interest rates. This generally stimulates business investment and consumer purchases, leading to an increase in aggregate demand. Choice B is incorrect because an increase in the money supply would typically cause the dollar to depreciate, not appreciate. Choice C is incorrect because lower interest rates would generally increase asset prices, not decrease them. Choice D is incorrect because an increase in the money supply would generally lead to an increase, rather than a decrease, in the general level of prices.

When the Fed Unexpectedly Increases the Money Supply, It Will