According to the interest rate effect, a decrease in the price level will
A) decrease the real value of money balances, which causes total planned real expenditures to increase.
B) cause interest rates to fall, which generates an increase in borrowing, so that total planned real expenditures increase.
C) lead to a decrease in net exports, which causes total planned real expenditures to decrease.
D) increase the real value of money balances, which causes interest rates to increase, thereby reducing total planned expenditures.

Question

Quizplus · Accepted Answer

According to the interest rate effect, a decrease in the price level causes a decrease in interest rates. This, in turn, generates an increase in borrowing, which increases total planned real expenditures. Therefore, choice (B) is the correct answer. Choices (A), (C), and (D) are all incorrect as they provide incorrect explanations of the interest rate effect.

According to the Interest Rate Effect, a Decrease in the Price