Answer:
An increase in the money supply will have the greatest effect on real gross domestic product if the quantity demanded of money in the economy is relatively insensitive to the changes in interest rate
Step-by-step explanation:
- In Macroeconomics or Monetary Economics, an increase in money supply basically implies an expansionary monetary policy leading to a reduction in the nominal interest, everything else in the economy held constant.
- It also leads to inflationary impacts in the economy reflected by an increase in the overall price level of goods and services.
- In money market, a reduction in interest rate would lead to an increase in quantity demanded for money as due to relatively lo interest rate the financial borrowers such as companies, commercial firms and investors would prefer to obtain higher capital or financial loans.
- On the other hand, inflation or higher overall price level of goods and services means lower consumer demand for those goods and services. Hence, any increase in production of goods and services due to higher investment or financial borrowings by businesses or commercial firms would be offset by the reduction in consume demand which can have a negative impact on the economy as a whole.
- Hence, if the quantity demanded for money by the financial and investment borrowers is relatively insensitive to changes in interest rate due to expansionary monetary policy, it can have a desirable effect on the real GDP level, in this case.