Exhibit 15-6 -If the Fed is targeting interest rates and money demand shifts from D_m to D_m' in Exhibit 15-6,the Fed will A)do nothing and the interest rate will rise to i' B)do nothing and the interest rate will settle at i C)decrease the money supply to restore its target of i D)increase the money supply to restore its target of i E)decrease money demand back to D_m to restore its target of i

Question

Quizplus · Accepted Answer

If money demand shifts from DS1U1B1mS1U1B0 to DS1U1B1mS1U1B0', the equilibrium interest rate will increase from i to i'. In order to maintain the target interest rate, the Fed will have to increase the money supply to shift the money supply curve outward to S1U1B1, restoring the equilibrium point to where it intersects the target interest rate i. Therefore, the correct choice is D, increase the money supply to restore its target of i.

Exhibit 15-6 -If the Fed Is Targeting Interest Rates and Money Demand