Does a Higher Rateof Growth of the Money Supply Lower Interest Rates? To answer the questionof Does a Higher Rate of Growth of the Money Supply Lower Interest Rates? Youhave to take a look at how interest rates are born into existence, a theory ofhow this comes to fruition is laid out in the liquidity preference framework.The liquidity preference framework examines the supply and demand formoney. the liquidity preferenceframework illustrates interest rates will vary, in the case that the requestfor money varies.
There are currentlyfour conceivable things on interest rates in an increased money supply. Whichare the liquidity effect, the income effect, the price level effect, andexpected inflation effect? However, out of the four, the liquidity effect isthe only known method that specifies that a higher rate of the money supplywould lower interest rates. The Liquidity Effect Using the liquidity effect a higher rate of growth of the moneysupply will lower interest rates. Interest rates decrease as soon as the moneysupply rises simply due to the circumstance that money has become moreabundant. Therefore, the more abundantthe money supply is the lower interest rate will be, which is called theliquidity effect and is the only method that specifies that a higher rate ofthe money supply would lower interest rates. There are three differentpossibilities in relations to the liquidity effect and its effect on interest. “theliquidity effect becomes less important, interest rates are found to be sensitiveto income and price effects” (Michis,2015).
First, there is an instancewhere the liquidity effect can override over all of the other effects in orderto get the interest rate to lower. This happens fast to lower, however as timepasses other effects begin to undo some of the declines. Due to the size of theaction in comparison to others, the interest rate will not return to itsoriginal rate.
Secondly, there is aninstance where the liquidity effect can be smaller than all of the othereffects, because of the expected inflation effect is slower moving becauseexpectations are slower moving to increase. In the beginning, the liquidityeffect causes interest rate to drop. However, the income price level starts toincrease the rate. Which happen due to the fact that these effects areoverriding, and the interest rate rises back to what it was in the beginning. Another instance in relation to the liquidity effect is when theexpected inflation effect overrides and moves fast, this is due to the factthat expectation raises when the rate of money increases. The expectedinflation effect will overrule the liquidity effect, which would cause interestrates to rise. That leads to price level effects which cause interest rate torise higher than before.
In the research and study of the question doesa higher rate of growth of the money supply lower interest rates? The answer isno. therefore, what should happen in an instance like this is that money growthmust be hindered to lower interest rates.” The evidence seems to indicate thatthe income price level expected inflation dominates the liquidity effect, thatan increase in money supply growth leads to higher rather than lower interestrates” (Mishkin,2016).So, looking into the liquidity preferenceframework and examining that the supply and demand for money will differinterest rate lower interest rate for a while, where the will eventually riseback to its initial level or potentially increasing. Things that should beconsidered when deciding on which route to take to lower interest rates.
Shouldbe based on the situation which method would give the favored outcome whetherit be in the present or in future.