Question

If the Federal Reserve held the money supply constant in response, the effect on aggregate demand from the increase in government spending would be:___.

Answer 1

Answer: Smaller

Explanation:

If the Federal Reserve held the money supply constant in response, the effect on aggregate demand from the increase in government spending would be smaller than if the Fed were committed to maintaining a fixed interest rate.

A rise in Aggregate Demand would lead to more people demanding money to enable them to spend. If the Fed keeps the money supply constant therefore, the increase aggregate demand will be less than if the Fed was committed to maintaining a fixed interest rate.

This is because if the Fed wanted to maintain a fixed rate they would have increased money supply to match money demand which would have led to Aggregate demand increasing more than if they hold the money supply constant.