Log out Go to App
Go to App

Learning Materials

Features

Discover

Chapter 5: Q.17 (page 164)

Why should a rise in the price level (but not in expected inflation) cause interest rates to rise when the nominal money supply is fixed?

Short Answer

Expert verified

The decrease in money's purchasing power, interest rates will rise.

Step by step solution

01

Introduction

Inflation is defined as a condition in which the price of all goods and services begins to rise, reducing people's real purchasing power.

02

Explanation

If the price level rises, the purchasing power of money falls, implying that a person will have to spend more money to buy the same products. When a result of this, people wish to keep their money as the price level rises. As a result, the demand curve for money will shift to the right in this situation. The interest rate rises as you move to the right.

As a result of the decrease in money's purchasing power, interest rates will rise.

Unlock Step-by-Step Solutions & Ace Your Exams!

  • Full Textbook Solutions

    Get detailed explanations and key concepts

  • Unlimited Al creation

    Al flashcards, explanations, exams and more...

  • Ads-free access

    To over 500 millions flashcards

  • Money-back guarantee

    We refund you if you fail your exam.

Start your free trial

Over 30 million students worldwide already upgrade their learning with Vaia!

One App. One Place for Learning.

All the tools & learning materials you need for study success - in one app.

Get started for free

Most popular questions from this chapter

M1 money growth in the U.S. was about 15%in localid="1647014587488" 2011and2012, and 10%in 2013. Over the same time period, the yield on 3-month Treasury bills was close to 0%. Given these high rates of money growth, why did interest rates stay so low, rather than increase? What does this say about the income, price-level, and expected-inflation effects

Suppose Maria prefers to buy a bond with a 7% expected return and 2% standard deviation of its expected return, while Jennifer prefers to buy a bond with a 4% expected return and 1% standard deviation of its expected return. Can you tell if Maria is more or less risk-averse than Jennifer?

One of the points made in this chapter is that inflation erodes investment returns. Go to http://www.moneychimp.com/articles/econ/inflation_calculator.htm and review how changes in inflation alter your real return using the second inflation calculator. What happens to the difference between the future value of an investment and its inflation-adjusted value as

a. inflation increases?

b. the investment horizon lengthens?

c. expected returns increase?

Explain why you would be more or less willing to buy long-term Delta Air Lines bonds under the following circumstances:

a. The company just released its financial statements, indicating that income decreased and liabilities increased.

b. You expect a bull market in stocks (stock prices are expected to increase).

c. You have analyzed your country’s monetary policy and expect interest rates to decrease.

d. Brokerage commissions on bonds fall.

e. Your income and wealth increased over the last two years.

Raphael observes that at the current level of interest rates there is an excess supply of bonds, and therefore he anticipates an increase in the price of bonds. Is Raphael correct?
See all solutions

What do you think about this solution?

We value your feedback to improve our textbook solutions.

Study anywhere. Anytime. Across all devices.

Sign-up for free