Consider the AD/AS model with a constant rate of inflation.In this situation,the money supply is rising,which tends to reduce interest rates.However,interest rates are actually likely to remain stable.Why?

Question

Quizplus · Accepted Answer

Inflation increases the demand for money as individuals and firms require more money to conduct transactions at higher prices. This increase in demand for money tends to push interest rates up. Therefore, even though the money supply is rising, the resulting increase in the demand for money is likely to keep interest rates stable or even push them up slightly. Option A is incorrect as the money transmission mechanism still applies in a situation of sustained inflation. Option B is incorrect because a decrease in demand for money will tend to reduce interest rates, not increase them. Options C and E are incorrect because they suggest that declining interest rates cause interest rates to rise, which is not possible.

Consider the AD/AS Model with a Constant Rate of Inflation