If the Fed holds the interest rate constant in response to an increase in government purchases,...
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If the Fed holds the interest rate constant in response to an increase in government purchases, the money supply will , and the impact on income will be than if the money supply were held constant.
a. increase, larger
b. increase, smaller
c. decrease, larger
d. decrease, smaller
Homework Answers
Ans. a) increase, larger
When the Fed tries to keep the interest rate constant when the government expenditure increases, it can do so by increasing the money supply so that the new intersection of the money demand and the money supply takes place at the same interest rate but a higher real GDP level. On the other hand, if the money supply were constant the interest rate would increase and the impact on income would remain the same i.e. the real GDP will remain constant.
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