Central banks generally prefer targeting the ____ and allowing the resulting _____ to adjust?
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Answer: B. interest rate equilibrium money supply
Explanation
Central banks commonly implement monetary policy by targeting interest rates and allowing the money supply to adjust endogenously. Modern monetary authorities set policy rates like the federal funds rate rather than fixing money aggregates. Commercial banks and public demand determine the exact equilibrium money supply based on the set interest rate. Controlling interest rates directly is more practical for central banks than managing volatile money demand. Liquidity preference theory shows how money supply and interest rates adjust to market conditions. Open market operations are used by central banks to maintain their target policy interest rate.
Financial markets watch central bank interest rate announcements closely to gauge future monetary conditions. Allowing money supply to adjust helps stabilize short-term borrowing costs for businesses and consumers. Central bank credibility depends on successfully managing interest rate targets during economic shifts. Targeting money demand directly is difficult because private liquidity preferences fluctuate unpredictably. Equilibrium money supply cannot be the primary policy target when money demand shifts constantly. Targeting interest rate and demand for money ignores the endogenous adjustment of the money supply.
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