In the short run,an unanticipated increase in the money supply will
A)increase interest rates and shift the aggregate demand curve to the left.
B)increase interest rates and shift the aggregate demand curve to the right.
C)lower interest rates and shift the aggregate demand curve to the left.
D)lower interest rates and shift the aggregate demand curve to the right.

Question

Quizplus · Accepted Answer

According to the classical view of the quantity theory of money, an increase in the money supply leads to a proportional increase in prices and nominal incomes in the economy, while the real interest rate remains unchanged. This is because the demand for money is a function of the nominal value of transactions in the economy, which is determined by prices and output. As a result, the real money supply and the real interest rate (i.e., adjusted for inflation) remain constant. However, in the short run, it is possible for interest rates to fall due to the liquidity effect, which occurs when the increase in the money supply leads to a surplus of money in the economy, causing people to hold more bonds and reducing interest rates. This effect is stronger in the short run than the long run, and can lead to an expansionary shift in the aggregate demand curve, as people have more money to spend and invest. Therefore, answer D is the correct choice.

In the Short Run,an Unanticipated Increase in the Money Supply