In a situation of inflationary pressure, an increase in the cash rate results in:Group of answer choicesan increase in real GDP, but a fall in the price level.a fall in real GDP but a rise in the price level.an increase in real GDP, but no change in the price level.a fall in the price level and real GDP.
Question
In a situation of inflationary pressure, an increase in the cash rate results in:Group of answer choicesan increase in real GDP, but a fall in the price level.a fall in real GDP but a rise in the price level.an increase in real GDP, but no change in the price level.a fall in the price level and real GDP.
Solution
In a situation of inflationary pressure, an increase in the cash rate results in a fall in the price level and real GDP.
Here's why:
Step 1: The cash rate is the interest rate that banks charge each other for short-term loans. When the central bank increases the cash rate, borrowing becomes more expensive.
Step 2: As borrowing becomes more expensive, businesses and consumers are likely to reduce their spending. This leads to a decrease in demand for goods and services.
Step 3: With decreased demand, businesses may need to lower their prices to sell their goods and services, leading to a fall in the price level (deflation).
Step 4: Additionally, with less spending and investment, the total output or real GDP of the economy is likely to decrease.
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