Question

Suppose the central bank engages in contractionary monetary policy that results in lower money growth This lower money growth will cause which of the following in the short run?

1 Lower real interest rates and lower nominal interest rates

2 Lower real interest rates and higher nominal interest rates

3 Higher real interest rates and higher nominal interest rates

4 Higher real interest rates and lower nominal interest rates

Answer 1

Option 3 : Higher real interest rates and higher nominal rates.

It The effectiveness of interest rates as a monetary policy tool is that there is a time lag between changing interest rates and the full effect being transmitted to the macroeconomy.

It could lead to higher real interest rates and higher nominal interest rates as it could lead to higher cost of borrowing from commercial banks reducing the amount of credit borrowed from them

Suppose an investor foresees a 7% interest rate and anticipates a 1% rise in the future interest rates then the real interest rate would be 6%.However it is to be borne in the mind that interest rates are volatile especially during periods of lower money growth.