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.