Question

Suppose a huge increase in credit card frauds leads to many businesses refusing to accept payments by credit cards. As a result, people want to keep more cash on hand, increasing the demand for money. Assume the Fed does not change the money supply. According to the theory of liquidity preference, the interest rate will __________ , which causes aggregate demand to_________
If instead the Fed wants to stabilize aggregate demand, it should ____________ the money supply by ____________ government bonds'

Answer 1

Answer:

Suppose a huge increase in credit card frauds leads to many businesses refusing to accept payments by credit cards. As a result, people want to keep more cash on hand, increasing the demand for money. Assume the Fed does not change the money supply. According to the theory of liquidity preference, the interest rate will __increase__ , which causes aggregate demand to__decrease_

If instead the Fed wants to stabilize aggregate demand, it should ___increase__ the money supply by _purchasing__ government bonds.

Explanation:

The economy's aggregate demand will increase as a result of the increased preference for liquidity leads to an increase in consumer spending, thereby increasing the Gross Domestic Product.  If the Fed increases the money supply in response to the increased preference for liquidity, it will cause a reduction in interest rates, thereby further increasing consumer spending.