If the central bank increases money supply, what will happen to product/service price in general and...

If the central bank increases money supply, what will happen to product/service price in general and interests in general?

The mechanism of how the change in money supply influences prices and interest rates should be clearly explained.

Expert Solution

Central Bank can increase the money supply by reducing the reserve requirement, discount rate or by conducting open market purchase of government securities from commercial banks. This is going to increase the reserves in the banking system and helps in increasing its lending capacity. now banks are equipped with more reserves so they generate loans and in order to attract borrowers the reduced the rate of interest. This shows that increase in the money supply will decrease the rate of interest. In the goods market this will result in increasing the investment and consumption. as a result aggregate demand is increased and the aggregate demand curve shifts to the right. With upward-sloping short run aggregate supply curve, this causes an increase in the general price level as well as the real GDP in the short run. In this manner increase in money supply increases the general price level in the short run but decreases the rate of interest

Rahul Sunny answered 2 years ago

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