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Which of the following best describes the​ "interest rate​ effect"? A. An increase in the price...

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

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Answer #1

Interest rate effect: An increase in price level decrease the saving of the household because they need more money for spending than before the price increase. As the saving falls, the shortage of loanable funds occurs as a result the interest rate increase which leads to fall in investment and consumption spending (because of high cost of borrowing).

Hence, an increase in price level leads to decease in aggregate demand in an economy via increase in interest rate.

Answer: option (B) i.e., An increase in the price level raises the interest rate and chokes off investment and consumption spending

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