Question

Suppose that in the economy, plants are operating at 65 percent of their capacities, and businesses are pessimistic about the future. If the Fed increases the money supply in an attempt to stimulate the economy, the most likely results are...

a) Increased economic growth and lower interest rates
b) Reduced economic growth and higher interest rates
c) Stable economic growth and unchanged interest rates
d) Increased inflation and reduced government spending

Answer 1

Increasing the money supply typically lowers interest rates and stimulates economic growth, making the most likely result 'increased economic growth and lower interest rates'.

Step-by-step explanation:

When the Federal Reserve increases the money supply, it typically does so with the goal of stimulating economic activity. An increase in the money supply often leads to lower interest rates, as there is more money available for banks to lend. This can encourage borrowing for investment and consumption, thus shifting the aggregate demand to the right. In the situation described, with plants operating at 65 percent of capacity and a pessimistic business outlook, increasing the money supply would be an effort to stimulate the economy by making borrowing cheaper and encouraging investment and spending.

In the short run, the most likely results of the Fed's action to increase the money supply would be increased economic growth due to higher spending and investment, and lower interest rates due to the increased money supply making loans cheaper. While this action could also lead to a higher price level or inflation, the risk is lowered by the current underuse of capacity and lack of business confidence.