Exhibit 15-4 -If the Fed is targeting interest rates and money demand shifts from D_m to D_m' in Exhibit 15-4,the Fed will A) do nothing and the interest rate will rise to i' B) do nothing and the interest rate will settle at i C) decrease the money supply to restore its target of i D) increase the money supply to restore its target of i E) decrease money demand back to D_m to restore its target of i

Question

Quizplus · Accepted Answer

When money demand shifts from DS1U1B1mS1U1B0 to DS1U1B1mS1U1B0', the interest rate rises to i'. The Fed targets interest rates, so it needs to increase the money supply to restore its target of i. This would shift the money supply curve to the right, back to S1U1B0. Increasing the money supply will lower the interest rate from i' back to i, which is the Fed's target. Therefore, the best choice is D.

Exhibit 15-4 -If the Fed Is Targeting Interest Rates and Money Demand