Question

Suppose that everyone's income fell nationwide and the central bank decided to purchase bonds. According to the Liquidity Preference Theory and everything else held constant, this would cause the nominal interest rate to _____.

Select one:

a. either increase, decrease, or remain constant

b. remain constant

c. decrease

d. not be affected

e. increase

Answer 1

National income level fells and the central bank decided to purchase bonds. According to the Liquidity Preference Theory and everything else held constant, this would cause the nominal interest rate to decrease.

In that case central bank tries to inject money into the economy by buying the bonds. As a result the money supply rise, which leads to decrease in nominal interest rate. As a result the investment level increases as well as aggregate demand increases.

Answer: Option (C)