Question

In​ Keynes's analysis of the speculative demand for​ money, what will happen to money demand if people suddenly decide that the normal level of the interest rate has​ declined? Why?

A. Money demand will increase because people will want to borrow more money.
B. Money demand will stay the same because the speculative component of the demand for money is viewed as insensitive to interest rates.
C. Money demand will decrease because as interest rates​ fall, the price of bonds rises. The relative increase in the expected return on bonds makes money less attractive.
D. Money demand will increase because as interest rates​ fall, the price of bonds falls. The relative decrease in the expected return on bonds makes money more attractive.

Answer 1

The correct answer is option C.

Step-by-step explanation:

When the interest rate falls below the normal level, people expect the interest rates to rise in future and bond prices to fall. This causes investors to sell the bonds at present so that they can buy bonds when they are selling at lower prices in future as of result of an increase in interest rates. Money demand will, as a result, will decrease.