The upward slope of the MP curve indicates that
A)the central bank lowers real interest rates when inflation rises.
B)the central bank raises real interest rates when inflation falls.
C)the central bank raises nominal interest rates when inflation rises.
D)the central bank raises real interest rates when inflation rises.

Question

Quizplus · Accepted Answer

The upward slope of the MP curve indicates that the central bank raises real interest rates when inflation rises. This is because as inflation increases, the central bank typically tightens monetary policy to cool down the economy and stabilize prices. This tightening often involves raising the nominal interest rate to reduce aggregate demand and bring inflation back down to its target level. However, because inflation erodes the purchasing power of money, a higher nominal interest rate may not be enough to induce individuals and firms to save and invest more. To encourage these behaviors, the central bank must also raise the real interest rate (i.e. the nominal rate adjusted for inflation) to make saving and investment more attractive. Thus, the upward slope of the MP curve reflects the positive relationship between real interest rates and inflation.

The Upward Slope of the MP Curve Indicates That