When money demand increases, the Fed cannot keep both the money supply and the interest rate from rising

Question

Quizplus · Accepted Answer

When money demand increases, people are willing to pay more for money, which means the interest rate must rise to keep supply and demand in equilibrium. If the Fed tries to keep the interest rate fixed by increasing the money supply, it will create excess demand for money, which will cause inflation. Therefore, the Fed cannot keep both the money supply and the interest rate from rising when money demand increases.

When Money Demand Increases, the Fed Cannot Keep Both the Money