The interest rate effect of a change in the aggregate price level occurs when:
A) a higher price level decreases the purchasing power of money,resulting in an increase in the interest rate.
B) the Bank of Canada uses contractionary monetary policy,causing an increase in the interest rate.
C) government borrowing in the loanable funds market raises the interest rate.
D) the price of a bond increases,reducing the interest rate.

Question

Quizplus · Accepted Answer

When the aggregate price level increases, the purchasing power of money decreases, as the same amount of money can buy fewer goods and services. As a result, individuals demand more money to maintain their desired levels of consumption and investment, leading to an increase in the interest rate. Thus, the interest rate effect is the tendency for an increase in the price level to raise the interest rate due to the increased demand for money.

The Interest Rate Effect of a Change in the Aggregate