Let's analyze the provided options in light of a decrease in the rate of interest:
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Decrease the opportunity cost of holding money: This is correct. When interest rates decrease, the opportunity cost of holding money (i.e., the interest income foregone by not investing in interest-bearing assets) also decreases.
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Increase the transactions demand for money: This is not directly affected by interest rates. The transactions demand is more related to the level of income and the frequency of transactions rather than interest rates.
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Increase the asset demand for money: When interest rates decrease, holding money becomes more attractive compared to holding interest-bearing assets, thus increasing the asset demand for money.
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Decrease the price of bonds: This statement is incorrect. Typically, when interest rates decrease, the price of existing bonds increases because older bonds with higher interest rates become more valuable in comparison to newer bonds issued at lower rates.
Therefore, the most accurate answers given a decrease in the rate of interest would be:
- Decrease the opportunity cost of holding money
- Increase the asset demand for money
If asked to choose one answer reflecting the primary effect, "decrease the opportunity cost of holding money" can be emphasized.
1 answer