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Question
Microeconomics
Posted 9 months ago
If there is rapid inflation throughout the economy, which of the following is the most likely result?
Choose 1 answer:
(A) The demand for money decreases and the nominal interest rate decreases.
(B) The demand for money decreases and the nominal interest rate increases.
(c) The money supply increases and the nominal interest rate decreases.
(D) The demand for money increases and the nominal interest rate increases.
(E) The money supply increases and the nominal interest rate increases.
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Answer from Sia
Posted 9 months ago
Solution
a
Rapid Inflation: Rapid inflation typically leads to a decrease in the demand for money because people prefer to hold less cash as its value erodes quickly
b
Nominal Interest Rate: With rapid inflation, nominal interest rates tend to increase as lenders demand higher rates to compensate for the loss of purchasing power
Answer
(B) The demand for money decreases and the nominal interest rate increases.
Key Concept
Rapid inflation and its impact on money demand and interest rates
Explanation
Rapid inflation decreases the demand for money as people avoid holding cash that loses value quickly. Simultaneously, nominal interest rates increase as lenders require higher returns to offset the inflation.
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