Question 27

An increase in the money supply by the Federal Reserve leads to a decrease in interest rates, stimulating investment and GDP.

When the Federal Reserve increases the money supply, it typically results in lower interest rates. These lower rates make borrowing cheaper, which encourages businesses to invest and consumers to spend, ultimately boosting gross domestic product (GDP).

A) The interest rates will decrease, which will, in turn, stimulate investment and gross domestic product (GDP).

This option accurately describes the impact of an increased money supply. Lower interest rates resulting from a higher money supply incentivize borrowing and spending, which propels investment and stimulates overall economic growth, thereby increasing GDP.

B) The interest rates will decrease, which will, in turn, decrease investment and gross domestic product (GDP).

This option incorrectly claims that a decrease in interest rates would lead to a decrease in investment and GDP. In reality, lower interest rates encourage investment, as they reduce the cost of borrowing, leading to economic stimulation rather than contraction.

C) The interest rates will increase, which will, in turn, decrease investment and gross domestic product (GDP).

This option misrepresents the relationship between money supply and interest rates. An increase in the money supply would not result in higher interest rates; instead, it typically causes interest rates to fall, which encourages investment and economic growth, not the decrease stated here.

D) The interest rates will increase, which will, in turn, stimulate investment and gross domestic product (GDP).

This option is incorrect as it suggests that an increase in interest rates would stimulate investment. Higher interest rates generally discourage borrowing and spending, leading to a reduction in investment and GDP growth, contrary to the dynamics of an increased money supply.

Conclusion

Option A is definitively correct as it aligns with the economic principle that an increase in the money supply lowers interest rates, fostering investment and enhancing GDP. All other options fail to accurately reflect the relationship between money supply, interest rates, and economic activity, leading to erroneous conclusions about their effects.