When the growth rate of the money supply increases,interest rates end up being permanently lower if
A)the liquidity effect is larger than the other effects.
B)there is fast adjustment of expected inflation.
C)there is slow adjustment of expected inflation.
D)the expected inflation effect is larger than the liquidity effect.

Question

Quizplus · Accepted Answer

The liquidity effect refers to the immediate, short-term impact of an increase in the money supply, which typically leads to lower interest rates as more funds are available for lending. If the liquidity effect is larger than other effects (such as the expected inflation effect, which can lead to higher interest rates as lenders demand higher returns to compensate for reduced purchasing power), then the initial decrease in interest rates can be sustained, leading to permanently lower interest rates.

When the Growth Rate of the Money Supply Increases,interest Rates