CA Foundation · Business Economics · Money Market
Starting from money market equilibrium, the central bank conducts open market purchases of government securities, increasing money supply while money demand stays unchanged. What is the likely result?
Open market purchases raise the money supply, shifting the supply curve rightward. Since money demand is unchanged, people will hold the extra money only at a lower opportunity cost, so the equilibrium interest rate falls and investment becomes cheaper.
- AThe money supply curve shifts right and the equilibrium interest rate fallsCorrect
- BThe money supply curve shifts right and the equilibrium interest rate rises
- CThe money demand curve shifts left and the equilibrium interest rate falls
- DThe money supply curve shifts left and the equilibrium interest rate rises
Explanation
Open market purchases inject money into the banking system, shifting the vertical supply curve to the right. With money demand unchanged, a lower interest rate is needed to induce people to hold the larger money stock. Hence the equilibrium rate falls; a rise would follow a supply decrease.
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