According to the theory of liquidity preference, tightening the money supply will ______ nominal interest rates in the short run, and, according to the Fisher effect, tightening the money supply will ______ nominal interest rates in the long run.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase

Question

Quizplus · Accepted Answer

According to the theory of liquidity preference, tightening the money supply (reducing the amount of money available) will increase nominal interest rates in the short run because less money means borrowers are willing to pay more for loans. According to the Fisher effect, in the long run, tightening the money supply can lead to lower inflation expectations, which in turn can decrease nominal interest rates because nominal interest rates are the sum of real interest rates and expected inflation.

According to the Theory of Liquidity Preference, Tightening the Money