Question

If the Federal Reserve significantly raises monetary growth (and this is unanticipated),  economic theory teaches that interest rates:

a. rise in the short run but fall below their initial level in the long run.

b. fall in the short run but rise above their initial level in the long run.

c. do not change.

d. rise in both the short and long run.

e. fall in both the short and long run.

Answer 1

b. fall in the short run but rise above their initial level in the long run.

the Fed increases money supply which decreases interest rate and increases consumption. it increases aggregate demand and shifts it to the right which increases real GDP.

The increased aggregate demand increases wages and input prices in the long run and shifts the aggregate supply to the left in the long run and that increases price level which increases money demand and that increases interest rates in the long run above the initial levels.