Suppose that households became mistrustful of the banking system and decide to decrease their chequing accounts and increase their holdings of currency.Using the money demand and money supply model and assuming everything else is held constant, the equilibrium interest rate should
A)increase.
B)decrease.
C)not change.
D)increase, then decrease.

Question

Quizplus · Accepted Answer

When households decide to decrease their chequing accounts and increase their holdings of currency, the money supply in the economy decreases. This is because currency is not a part of the money supply as defined by economists. As the money supply decreases, the demand for money remains constant, leading to an increase in the equilibrium interest rate. This is because as the demand for money is greater than the available supply, lenders will demand a higher interest rate to compensate for the scarcity of funds. Therefore, the equilibrium interest rate should increase in this scenario.

Suppose That Households Became Mistrustful of the Banking System and Decide