Question

When the Federal Reserve _____ the money supply, it also _____ interest rates.

Answer 1

It increases and lowers.

Answer 2

The right answer is a. increases, lowers. Money demand for money and interest rate are inversely related. With the increase in the money supply, some people will demand more goods and services, and some people will deposit some of their money in banks. As a result of this excess reserves, banks will want to lend more money, and to achieve this they will lower interest rate. This will increase investment and consumption.