Which of the following best describes the cause-and-effect chain of a restrictive monetary policy? An increase in the money supply will lower the interest rate, decrease investment spending, and increase aggregate demand and GDP. A decrease in the money supply will lower the interest rate, increase investment spending, and increase aggregate demand and GDP. An increase in the money supply will raise the interest rate, decrease investment spending, and decrease aggregate demand and GDP. A decrease in the money supply will raise the interest rate, decrease investment spending, and decrease aggregate demand and GDP.
Question
Which of the following best describes the cause-and-effect chain of a restrictive monetary policy? An increase in the money supply will lower the interest rate, decrease investment spending, and increase aggregate demand and GDP. A decrease in the money supply will lower the interest rate, increase investment spending, and increase aggregate demand and GDP. An increase in the money supply will raise the interest rate, decrease investment spending, and decrease aggregate demand and GDP. A decrease in the money supply will raise the interest rate, decrease investment spending, and decrease aggregate demand and GDP.
Solution
The best description for the cause-and-effect chain of a restrictive monetary policy is: "A decrease in the money supply will raise the interest rate, decrease investment spending, and decrease aggregate demand and GDP."
Here's why:
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A restrictive monetary policy is typically implemented by a central bank to control inflation. This is done by decreasing the money supply in the economy.
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When the money supply decreases, it becomes more expensive to borrow money because there is less of it available. This causes the interest rate to rise.
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As the interest rate rises, it becomes more expensive for businesses and individuals to borrow money for investment purposes. This leads to a decrease in investment spending.
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When investment spending decreases, it reduces the overall demand for goods and services in the economy, known as aggregate demand.
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A decrease in aggregate demand can lead to a decrease in the Gross Domestic Product (GDP), as there is less overall economic activity.
So, the chain of cause and effect in a restrictive monetary policy goes from a decrease in the money supply to an increase in interest rates, which leads to a decrease in investment spending, followed by a decrease in aggregate demand and GDP.
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