Question2 According to the loanable funds approach, an increase in inflation expectations will have the following immediate effect: Shift both the demand and supply curves to the right Only the supply curve shifts to the left, while the demand curve remains unchanged. Shift both the demand and supply curves to the left Shift the demand curve to the right and the supply curve to the left Only the demand curve shifts to the right, while the supply curve remains unchanged. Shift the demand curve to the left and the supply curve to the right ResetMaximum marks: 0.59 Flag question undefined

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BlackTom AI · Accepted Answer

Question restatement: The prompt asks about the immediate effect on the loanable funds diagram when inflation expectations rise, according to the loanable funds approach, and provides several possible shifts for the demand and/or supply curves.
Option 1: 'Shift both the demand and supply curves to the right.' This would mean that both borrowers’ demand for loanable funds and savers’ supply of funds increase. However, higher inflation expectations typically alter real returns differently for borrowers and savers, so this simultaneous rightward shift is unlikely to be the immediate reaction in the standard model.
Option 2: 'Only the supply curve shifts to the left, while the demand curve remains unchanged.' A leftward shift of supply (fewer funds supplied) with demand unchanged would imply savers reduce saving without any change in borrowing demand. While inflation expectations can influence saving behavior, the classic result in the loanable funds framework under higher expected inflation is not typically a purely supply-side tightening with no demand response.
Option 3: 'Shift both the demand and supply curves to the left.' A leftward shift of both curves would indicate a withdrawal of both borrowing and saving activity. The model usually treats expected inflation as a factor that affects the relative attractiveness of borrowing versus saving in opposite directions, so a simultaneous left shift is not the standard immediate outcome.
Option 4: 'Shift the demand curve to the right and the supply curve to the left.' This combination means borrowers want more funds while savers supply less. This aligns with the intuition from the Fisher effect and the loanable funds framework: higher expected inflation tends to raise the nominal rate, eroding real returns from saving (reducing supply) and making borrowing more attractive (increasing demand). The net effect is a higher interest rate driven by a stronger demand for funds and weaker supply of funds.
Option 5: 'Only the demand curve shifts to the right, while the supply curve remains unchanged.' A pure demand-side expansion with unchanged supply could occur, but the standard analysis with rising inflation expectations also affects savers’ incentives, typically reducing the willingness to supply funds, making this option incomplete.
Option 6: 'Shift the demand curve to the left and the supply curve to the right.' This opposite pattern would imply borrowing becomes less attractive while saving becomes more attractive, which contradicts the conventional explanation that higher expected inflation reduces the real return to saving and encourages borrowing.
In summary, the most consistent interpretation within the loanable funds framework is that higher inflation expectations boost desired borrowing (demand shifts right) while reduce saving effort (supply shifts left), producing the option that has demand shifting right and supply shifting left.

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