QuestionAugust 11, 2025

If the economy is at potential output and the Fed increases the money supply, in the short run interest rates will likely: A) increase. B) decrease. C) remain constant. D) fluctuate randomly.

If the economy is at potential output and the Fed increases the money supply, in the short run interest rates will likely: A) increase. B) decrease. C) remain constant. D) fluctuate randomly.
If the economy is at potential output and the Fed increases the money supply, in the short run interest rates will likely: A) increase. B) decrease. C) remain constant. D) fluctuate randomly.

Solution
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Answer

B) decrease. Explanation 1. Understand the effect of increasing money supply Increasing the money supply typically lowers interest rates in the short run because more money is available for lending. 2. Apply the liquidity preference theory According to the liquidity preference theory, **interest rates decrease** when the money supply increases, as people have more cash and banks lower rates to encourage borrowing.

Explanation

1. Understand the effect of increasing money supply<br /> Increasing the money supply typically lowers interest rates in the short run because more money is available for lending.<br /><br />2. Apply the liquidity preference theory<br /> According to the liquidity preference theory, **interest rates decrease** when the money supply increases, as people have more cash and banks lower rates to encourage borrowing.
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