When would an increase in the money supply immediately increase the interest rate?

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The conventional wisdom as per economic theory is that an increase in monetary supply leads to a decrease in interest rates. The circumstances that cause interest rates to rise are not natural ones—they result from the power of the Federal Open Market Committee, which itself includes members of the Federal Reserve Board (popularly known as "The Fed"). The Fed will raise interest rates to curb the inflation that would result if the monetary supply is exceeding large. It is important to note, however, that this is not a natural process.


Another consideration is what an increase in the monetary supply means. An increase in the money supply occurs when the Fed is buying securities from banks in the open market and the amount of reserves in the banking system rises. Because banks have more money to lend, the supply of money goes up. If demand remains the same, interest rates (the natural correcting force) should actually drop. The circumstance wherein interest rates increase is usually due artificial processes whereby the Fed raises rates itself to prevent rampant economic inflation.

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An increase in the money supply could eventually lead to an increase in interest rates. When the money supplies increases, people have more money to spend or invest. As more money is invested, this can increase the number of jobs available. With more people working, people will be making more money. Most likely, they will spend it on goods and services. When the demand for goods and services increases, prices will rise if the supply of those goods and services stays the same. This will cause inflation. To slow down the economy, the Federal Reserve Board will increase interest rates. This means fewer people will borrow money to buy items or to invest in businesses. If there is less investment in businesses or the economy, fewer jobs will be created. If people have less money, or if it is more expensive to borrow money, people will demand fewer products. This will bring prices down and lower inflation. When the economy becomes too active, interest rates usually rise to slow the growth to some degree.

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