18. Which of the following scenarios will have an increase in the growth rate of the money supply when the liquidity effect is greater than the income effect the price-level effect and the expected-inflation effect?
Answer: C
The interest rate rises initially then falls but to a long-run level higher than the initial level.
When the liquidity effect is greater than the income effect, price-level effect, and expected-inflation effect, the scenario where the interest rate rises initially and then falls to a higher long-run level indicates that the growth rate of the money supply will increase.
A) The interest rate falls initially then rises but to a long-run level higher than the initial level
This scenario suggests an initial decrease in interest rates, which could imply an expansionary monetary policy. However, the rise to a long-run level higher than the initial level may not sufficiently reflect the dynamics of the liquidity effect dominating the other effects in increasing the money supply growth rate.
B) The interest rate rises initially then falls but to a long-run level lower than the initial level
In this case, although the interest rate rises initially, the long-run level is lower than the initial level. This indicates a contractionary effect, where the overall growth rate of the money supply would likely decrease rather than increase, contrary to the conditions specified in the question.
C) The interest rate rises initially then falls but to a long-run level higher than the initial level
This scenario is accurate because it captures the essence of the liquidity effect being dominant. The initial rise in interest rates followed by a decline to a higher long-run level suggests that the money supply is able to grow more significantly due to the liquidity effect's influence, thus fulfilling the condition in the question.
D) The interest rate falls initially then rises but to a long-run level lower than the initial level
Here, the initial fall in interest rates does not align with the expected outcomes of an increased money supply growth rate. The subsequent rise to a lower long-run level indicates a restrictive monetary environment, which would not support an increase in the growth rate of the money supply.
Conclusion
Option C is the only scenario that aligns with the condition where the liquidity effect outweighs the other effects, leading to an increase in the growth rate of the money supply. All other options present scenarios that either do not reflect a rise in the long-run interest rates or suggest conditions that would lead to a reduction in the money supply growth rate. Thus, C stands out as the correct choice.