The theory of liquidity preference assumes that the nominal supply of money is determined by which of the following?
A) the level of real GDP
B) the rate of inflation
C) government spending
D) the central bank

Question

Quizplus · Accepted Answer

The theory of liquidity preference, developed by John Maynard Keynes, assumes that the nominal supply of money is determined by the central bank, which can control the money supply through various monetary policy tools. The theory states that people hold money for three reasons: transactions, precautionary, and speculative. When the interest rate is high, people prefer to hold less money and save more, which reduces aggregate demand and lowers output. On the other hand, when the interest rate is low, people prefer to hold more money, which increases aggregate demand and raises output. Therefore, the central bank can use its monetary policy tools, such as open market operations, discount rate, and reserve requirements, to influence the interest rate and stabilize the economy. Real GDP, inflation, and government spending may affect the demand for money, but they are not the primary determinants of the nominal supply of money.

The Theory of Liquidity Preference Assumes That the Nominal Supply