Which of the following best describes the "interest rate effect"?
A)An increase in the price level raises the interest rate and chokes off government spending.
B)An increase in the price level lowers the interest rate and chokes off government spending.
C)An increase in the price level raises the interest rate and chokes off investment and consumption spending.
D)An increase in the price level lowers the interest rate and chokes off investment and consumption spending.

Question

Quizplus · Accepted Answer

The "interest rate effect" refers to the fact that an increase in the price level will generally lead to an increase in the nominal interest rate. This is because lenders will demand higher interest rates to compensate for the reduced purchasing power of money that comes with higher prices. The higher interest rates, in turn, will reduce investment and consumption spending, as borrowing becomes more expensive. Therefore, option C ("An increase in the price level raises the interest rate and chokes off investment and consumption spending") is the best choice.

Which of the Following Best Describes the "Interest Rate Effect