Question

According to the theory of liquidity preferences, expanding the money supply will _____ nominal interest rates in the short run, and, according to the Fischer effect, expanding the money supply will _____ nominal interest rates in the long run. Group of answer choices increase; increase; increase; decrease decrease; increase decrease; decrease

Answer 1

Answer: decrease; increase

Step-by-step explanation:

According to the Liquidity Preference theory, in the short run, increasing money supply will mean that there is more money in the economy which translates to more money for investment. This will lead to a decrease in interest rates as there are more sources of investment.

In the long run however, the Fischer effect shows interest will move with inflation. If money supply is expanded, it will lead to inflation in the long run because there will be more demand. This rise in inflation will cause interest rates to rise as well.