When the Bank of Canada responds to higher inflation by raising real interest rates,
A) consumption and investment spending rise and,thus,aggregate demand increases.
B) consumption and investment spending fall and,thus,aggregate demand increases.
C) consumption and investment spending rise and,thus,aggregate demand decreases.
D) consumption and investment spending fall and,thus,aggregate demand decreases.
E) the Bank of Canada changes its policy reaction function.

Question

Quizplus · Accepted Answer

When the Bank of Canada responds to higher inflation by raising real interest rates, the cost of borrowing increases, which leads to a decrease in consumption and investment spending. This, in turn, decreases aggregate demand in the economy. Therefore, option D is the correct answer. Options A, B, and C are incorrect as they suggest that consumption and investment spending rise with an increase in real interest rates, which is not the case. Option E is also incorrect as it is not relevant to the given scenario.

When the Bank of Canada Responds to Higher Inflation by Raising