Question

If the next chair of the Federal Reserve Board has a reputation for advocating an even slower rate of money growth than the current​ chair, what will happen to interest​ rates?

Answer 1

Slower money growth will lead to a liquidityy effect, which will raise interest rates; howe, the lower income, price level, and inflation will tent to lower interest rates.

Answer 2

There are three possible situations for what will happen:

(1) if the liquidity effect is larger than the other effects such as price, income, inflation etc, then interest rates will increase.

(2) if the liquidity effect is smaller than the other effects and expected inflation adjust gradually, then interest rates will increase at first but will be expected to later fall below their initial level.

(3) if the liquidity effect is smaller than the expected inflation effect and there is rapid adjustment of expected inflation, then interest rates will immediately fall or decrease.

Explanation: when the money growth rate is slow, it will lead to a liquidity effect, which will raise interest rates; however, the lower income,price level, and inflation will tend to lower interest rates.

The slower rate of money growth will also lead to a liquidity effect, which raises interest rates, while the lower price level, income, and inflation rates in the future will tend to lower interest rates. So there are three possible situations for what will happen:

(1) if the liquidity effect is larger than the other effects, then interest rates will rise or increase.

(2) if the liquidity effect is smaller than the other effects and expected inflation adjusts slowly, then interest rates will rise at first but will eventually fall below their initial level.

(3) if the liquidity effect is smaller than the expected inflation effect and there is rapid adjustment of expected inflation, then interest rates will immediately fall.