Question

If the next chair of the Federal Reserve Board has a reputation for advocating an even slower rate of money growth than the current chair, what will happen to interest rates? Discuss the possible resulting situations.

Short answer

These three alternatives are viable.

Step-by-step solution

Introduction

Inflation is defined as a condition in which the price of all goods and services begins to rise, reducing people's real purchasing power.

Explanation

A rise in the money supply will shift the money supply curve to the right, lowering the interest rate. A rise in the price level, inflation, and income, on the other hand, will shift the money demand curve to the right. The price level will rise when the demand curve shifts to the right.

There are three main possibilities that could occur. To begin with, if the liquidity effect is greater than the other influences, the interest rate will fall. Second, if the liquidity effect is smaller than the other effects, the interest rate will first rise but subsequently decline due to the other causes. Finally, if predicted inflation is greater than the liquidity effect, the interest rate will decrease.

As a result, these three alternatives are viable.