Which of the following events would most likely cause interest rates to increase?

• A. There is a decrease in demand for loans
• B. The central bank reduces the money supply
• C. The central bank lowers the reserve requirement for banks
• D. The government increases its spending without raising taxes

Answer: (B)

Verified step by step guidance

1. Step 1: Understand the relationship between money supply and interest rates. When the central bank reduces the money supply, there is less money available in the banking system for lending.
2. Step 2: Recall that interest rates are the 'price' of borrowing money. When the supply of money decreases, the price of borrowing (interest rates) tends to rise due to scarcity.
3. Step 3: Analyze the other options: a decrease in demand for loans would typically lower interest rates, since fewer people want to borrow money.
4. Step 4: Lowering the reserve requirement for banks increases the money supply, which tends to decrease interest rates, the opposite of what the question asks.
5. Step 5: Government increasing spending without raising taxes may increase demand for loans, potentially raising interest rates, but the direct and most certain cause of increased interest rates is the central bank reducing the money supply.