If the economy is in a recession, and real GDP decreases, the demand curve for money will shift to the

• A. Depression; right
• B. Recession; left
• C. Expansion; left
• D. Recession; right

Answer: (B)

When real GDP falls, the transactions demand for money declines. Money demand rises with income, so a drop in income means people and businesses want to hold less money for transactions. That makes the money-demand curve shift to the left. In the short run, the money supply is typically held fixed by the central bank, so the leftward shift leads to a lower equilibrium interest rate. This scenario matches a recession with a leftward shift in money demand. The other options would imply higher money demand (a rightward shift) or use a different phase of the business cycle that doesn’t fit the situation.