Suppose the money market has an equilibrium interest rate of 10 percent. If the actual interest is 8 percent, which of the following occurs to bring the money market back to equilibrium?

Question

Quizplus · Accepted Answer

If the actual interest rate is below the equilibrium interest rate, it means there is excess demand for bonds. To reduce the excess demand, people will start selling bonds, which will decrease the price of bonds. As bond prices and interest rates are inversely related, a decrease in bond prices will cause the interest rate to rise until it reaches the equilibrium interest rate. Therefore, people selling bonds will cause the price of bonds to fall and the interest rate to rise until it reaches the equilibrium level. Choice D correctly describes this process.

Suppose the Money Market Has an Equilibrium Interest Rate of 10