1. State whether you agree or disagree with the following statements and explain why.

a. When the real economy expands (Y rises), the demand for money expands. As a result, households hold more cash and the supply of money expands.

b. Inflation, a rise in the price level, causes the demand for money to decline. Because inflation causes money to be worth less, households want to hold less of it.

c. If the Fed buys bonds in the open market and at the same time we experience a recession, interest rates will no doubt rise.

2. During 2003, we began to stop worrying that inflation was a problem. Instead, we began to worry about deflation, a decline in the price level.Assume that the Fed decided to hold the money supply constant.What impact would deflation have on interest rates?