As the price level rises, interest rates will increase, and investment and consumption will fall.

Question

Quizplus · Accepted Answer

This is a basic principle of macroeconomics known as the "interest rate effect." As the price level rises, people will need more money to purchase goods and services, which increases the demand for money. This, in turn, causes interest rates to rise as lenders naturally charge more for borrowing. Higher interest rates will discourage borrowing and investment because the cost of borrowing is now more expensive. Likewise, consumption will fall because higher interest rates lead to more expensive credit and higher mortgage payments, which decreases people's disposable income.

As the Price Level Rises, Interest Rates Will Increase, and Investment