When Paul Volcker tightened the money supply:
A) the inflation rate immediately fell.
B) nominal interest rates fell in the short run.
C) nominal interest rates fell in the long run.
D) real balances rose in the short run.

Question

Quizplus · Accepted Answer

When Paul Volcker tightened the money supply, it initially led to higher nominal interest rates in the short run as the supply of money decreased. However, in the long run, as inflation expectations adjusted downward due to the tighter monetary policy, nominal interest rates fell. This is because the real interest rate is approximately the nominal interest rate minus the inflation rate. As inflation decreased over time, nominal rates also decreased to reflect the lower inflation environment.

When Paul Volcker Tightened the Money Supply