Incorporating the liquidity preference function into the simple model changes its outcome somewhat. What is the impact?
A) Changes in the growth of the money supply cause inflation and nominal interest rates to change, which affects demand for real balances and causes further discontinuous influences on prices.
B) Changes in the inflation rate no longer affect nominal interest rates: the Fisher effect is no longer operative.
C) Changes in nominal interest rates have an immediate effect on the real exchange rate, bypassing the adjustment process.
D) Changes in the money growth rate increase real balances, since prices are no longer flexible.

Question

Quizplus · Accepted Answer

Incorporating the liquidity preference function introduces the concept of demand for money, which in turn affects the impact of changes in the money supply. Changes in the growth of the money supply cause inflation and nominal interest rates to change, which affects demand for real balances and causes further discontinuous influences on prices.

Incorporating the Liquidity Preference Function into the Simple Model Changes