Question

Suppose the money supply increased 30 days ago. Whether the nominal interest rate is higher, lower, or the same today as it was 30 days ago depends on what? Explain your answer.

Short answer

The nominal interest rate today, in relation to 30 days ago when there was an increase in the money supply, could be higher, lower, or the same depending on multiple factors. While the liquidity preference theory suggests that an increase in money supply would lead to a decrease in interest rates, other factors such as reactions from the central bank, market expectations, and economic conditions also play a significant role.

Step-by-step solution

Understanding the Concepts

The nominal interest rate can be influenced by various factors such as inflation, central bank policy, and the overall economic growth. Meanwhile, the money supply represents the total amount of monetary assets available in an economy at a specific time. In this exercise, it is given that the money supply has increased.

Relating Money Supply to Nominal Interest Rates

According to the liquidity preference theory, an increase in the supply of money typically causes a decrease in interest rates. This happens because when there is more money in the system, it becomes more readily available for lending, hence reducing the cost of borrowing, which in turn decreases the interest rates. However, this is not always the case and can depend on how the market reacts to this increase.

Considering Other Influencing Factors

While the liquidity preference theory gives us a basic idea, it does not exist in a vacuum. Other factors such as reactions from the central bank, expectations of inflation, or other economic indicators also play a role in determining the final impact on the nominal interest rate. These factors can cause the interest rate to be higher, lower, or the same as it was 30 days ago.