Question

According to the theory of liquidity preference, RBA can decrease the ................ of money and .................... the interest rate

Group of answer choices

A. supply, lower

B. demand, lower

C. demand, raise

D. supply, raise

Answer 1

The correct option is b.

a) If the supply of money is decreased, it will lead to increase in the rate of interest. The rate of interest will not lower with reduction in supply of money.

b) If the demand of money will reduce, the interest rate will reduce. This will make saving unattractive and people will not keep money in liquid form and the cost of borrowing will also reduce. So investment will increase if RBA decreases demand of money.

c) If the demand of money is decreased, the interest rate will fall down instead of getting raised.

d) With the decrease in the supply of money, interest rate will rise. This will make savings attractive for people and the problem of liquidity trap will not be solved by RBA.