Question

If people could no longer borrow money to purchase cars, houses, and other expensive items:

a) Inflation would decrease
b) Interest rates would rise
c) Money supply would increase
d) Deflation would occur

Answer 1

The correct answer is option d) Deflation would occur.

Step-by-step explanation:

If people could no longer borrow money to purchase cars, houses, and other expensive items, it's likely that deflation would occur. Deflation is when the value of currency increases over time, which can have negative effects on economic growth. This happens because as currency becomes scarce, its value goes up. In this scenario, individuals who need to borrow money face stiff competition to obtain loans, and lenders can set high rates due to the increased value of currency over time.

Additionally, banks benefit from simply hoarding cash as money grows in value. On the other hand, those with existing debts such as farmers, must repay their loans with dollars that are worth more than when they borrowed, amplifying their financial burden.

Furthermore, contractionary policy that reduces the supply of loanable funds leads to a higher price for borrowing, which in this case is the interest rate. With less supply and unchanged demand, the cost of borrowing money tends to rise due to the greater scarcity of funds. Lastly, changes in consumer optimism and spending behavior can accelerate or decelerate economic activity, influencing the velocity with which money changes hands in the economy.