Question

Suppose the Reserve Bank of Australia pursues contractionary monetary policy. This policy move will tend to cause:

Select one:

a. a decrease in  i in the medium run and no change in  r in the medium run.

b. an increase in  i in the medium run and no change in  r in the medium run.

c. no change in  i in the medium run and an increase in  r in the medium run.

d. a decrease in  i in the medium run and a decrease in  r in the medium run.

e. no change in  i in the medium run and a decrease in  r in the medium run.

Answer 1

Option B is correct

contractionary monetary policy is aimed at increasing the rate of interest in the market in order to depress investment and aggregate demand. We know that long run or medium run experience no real change with means there is no change in the real variables such as real interest rate. But in the short run real variables can change. In this case there will be a change in the real interest rate in the short run but nominal interest rate will increase in the medium run to keep the real interest rate unchanged.