The interest-rate effect is described as an increase in the price level which:
A)raises the interest rate, thereby reducing government spending.
B)lowers the interest rate, thereby reducing government spending.
C)raises the interest rate, thereby reducing investment and consumption spending.
D)lowers the interest rate, thereby reducing investment and consumption spending.

Question

Quizplus · Accepted Answer

The interest-rate effect is a component of the overall aggregate demand (AD) theory, which argues that a change in the price level triggers a change in the interest rate, which ultimately affects aggregate demand. As prices rise, people need more money to pay for things, and thus, they withdraw a greater percentage from their bank accounts, causing banks to raise interest rates. Higher interest rates discourage both investment and consumption spending, as borrowing becomes more expensive. Therefore, the correct option is C.

The Interest-Rate Effect Is Described as an Increase in the Price