In the money demand framework, when the interest rate falls, what happens to the quantity of money demanded?

In the money demand framework, when the interest rate falls, what happens to the quantity of money demanded?

• A. It increases
• B. It decreases
• C. It remains unchanged
• D. It becomes volatile

Answer: (A)

When the interest rate falls, the opportunity cost of holding money falls too. In the money demand framework, people balance two motives for holding money: transactions (driven by income and prices) and asset demand (driven by the return on alternative assets). The asset demand for money moves inversely with the interest rate: lower interest means holding money becomes relatively more attractive than buying bonds or other interest‑bearing assets. As a result, for the same income and price level, the quantity of money people want to hold increases. So the money-demand response is to rise when the interest rate decreases.

When the interest rate falls, the opportunity cost of holding money falls too. In the money demand framework, people balance two motives for holding money: transactions (driven by income and prices) and asset demand (driven by the return on alternative assets). The asset demand for money moves inversely with the interest rate: lower interest means holding money becomes relatively more attractive than buying bonds or other interest‑bearing assets. As a result, for the same income and price level, the quantity of money people want to hold increases. So the money-demand response is to rise when the interest rate decreases.