WBCS.LIVE practice question

If the interest rate goes up, the demand for money will _________.

Solve this multiple-choice question and check the correct answer with its explanation below.

Answer options

  1. first rise and then falls
  2. rise
  3. remain the same
  4. fall

Correct answer and explanation

Correct answer: fall

Explanation: According to the liquidity preference theory, there is an inverse relationship between interest rate and demand for money. When interest rates rise, people prefer to keep their wealth in interest-bearing assets (like bonds) rather than holding cash, so the demand for money falls. Conversely, when interest rates decline, holding money becomes more attractive, increasing demand for cash balances. This principle is central to the working of monetary policy.