The Money Market and the Interest Rate ECONOMICS

Figure 1 The Money Demand Curve Interest Rate 6% The money demand curve is

Figure 2 A Shift in the Money Demand Curve Interest Rate An increase in

Figure 3 Shifts and Movements Along the Money Demand Curve: A Summary Interest Rate

Figure 4 The Supply of Money Interest Rate 6% 3% E J 500 700

Figure 5 Money Market Equilibrium Interest Rate At the equilibrium interest rate of 6%,

How the Money Market Reaches Equilibrium Interest rate higher than equilibrium Excess supply of

How the Money Market Reaches Equilibrium Interest rate lower than equilibrium Excess demand for

How the Fed Changes the Interest Rate Fed conducts open market purchases Money supply

Figure 6 An Increase in the Money Supply At point E, the money market

How the Fed Changes the Interest Rate Fed conducts open market sales Money supply

Figure 7 Monetary Policy and the Economy (a) Interest Rate 6% 4. 5% 3%

Figure 8 Fiscal Policy and the Money Market (a) Ms Interest Rate 8% 6%

Figure 9 Interest Rate Expectations Interest Rate Ms 10% 5% E 500 Money ($

Figure 10 a The Fed in Action: 2001 (a) Interest Rate 6. 4% A

Figure 10 b The Fed in Action: 2001 (b) Real Aggregate Expenditure ($ Billions)

Figure 10 c The Fed in Action: 2001 (c) Money (M 1) ($ Billions)

Figure 10 d The Fed in Action: 2001 (d) Federal Funds Rate Percent which

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Figure 1 The Money Demand Curve Interest Rate 6% The money demand curve is drawn for a given real GDP and a given price level. E At an interest rate of 6 percent, $500 billion of money is demanded. F 3% If the interest rate drops to 3 percent, the quantity of money demanded increases to $800 billion. Md 500 800 Money ($ Billions)

Figure 2 A Shift in the Money Demand Curve Interest Rate An increase in real GDP or in the price level will shift the money demand curve rightward. At any interest rate, more money will be demanded after the shift. 6% E 3% 500 G F H 700 800 1, 000 Money ($ Billions)

Figure 3 Shifts and Movements Along the Money Demand Curve: A Summary Interest Rate 9% 6% Interest rate ↑ moves Rate us leftward along the money demand curve C A Entire money demand curve shifts rightward if the price level or income increases Interest rate ↓ moves us rightward along the money demand curve B 3% 300 500 800 Money ($ Billions)

Figure 4 The Supply of Money Interest Rate 6% 3% E J 500 700 Money ($ Billions)

Figure 5 Money Market Equilibrium Interest Rate At the equilibrium interest rate of 6%, the public is content to hold the quantity of money it is actually holding. Ms At a higher interest rate, an excess supply of money causes the interest rate to fall. 9% E 6% At a lower interest rate, an excess demand for money causes the interest rate to rise. 3% Md 300 500 800 Money ($ Billions)

How the Money Market Reaches Equilibrium Interest rate higher than equilibrium Excess supply of money Excess demand for bonds Price of bonds

How the Money Market Reaches Equilibrium Interest rate higher than equilibrium Excess supply of money and excess demand for bonds Price of bonds Interest rate

How the Money Market Reaches Equilibrium Interest rate lower than equilibrium Excess demand for money and excess supply of bonds Price of bonds Interest rate

How the Fed Changes the Interest Rate Fed conducts open market purchases Money supply Excess supply of money and excess demand for bonds Price of bonds Interest rate

Figure 6 An Increase in the Money Supply At point E, the money market is in equilibrium at an interest rate of 6 percent. Interest Rate 6% E 3% F To lower the interest rate, the Fed could increase the money supply to $800 billion. The excess supply of money (and excess demand for bonds) would cause bond prices to rise, and the interest rate to fall until a new equilibrium is established at point F with an interest rate of 3 percent. Md 500 800 Money ($ Billions)

How the Fed Changes the Interest Rate Fed conducts open market sales Money supply Excess supply of money and excess demand for bonds Price of bonds Interest rate

Figure 7 Monetary Policy and the Economy (a) Interest Rate 6% 4. 5% 3% Real Aggregate Expenditures ($ Trillions) H E F 500 800 Money ($ Billions) AEr = 4. 5% H AEr = 6% E (b) 45° 8 10 Real GDP ($ Trillions)

Monetary Policy and the Economy

Increase In Government Purchases

Figure 8 Fiscal Policy and the Money Market (a) Ms Interest Rate 8% 6% L E Money ($ Billions) 500 Real Aggregate Expenditures ($ Trillions) L F AEr = 8% AEr = 6% E (b) 45° 10 15 13. 5 Real GDP ($ Trillions)

Figure 9 Interest Rate Expectations Interest Rate Ms 10% 5% E 500 Money ($ Billions)

Figure 10 a The Fed in Action: 2001 (a) Interest Rate 6. 4% A During 2001, the Fed repeatedly increased the money supply. . . 3. 1% C $1, 093 1, 170 Money ($ Billions)

Figure 10 b The Fed in Action: 2001 (b) Real Aggregate Expenditure ($ Billions) A C AEr = 6. 4% AEr = 3. 1% AEpossible severe recession B The result: the economy moved from A to C instead of A to B and the decrease in GDP was smaller. 45° 9, 000 9, 243 9, 130 Real GDP ($ Billions)

Figure 10 c The Fed in Action: 2001 (c) Money (M 1) ($ Billions) 1, 200 During 2001, the Fed repeatedly increased the money supply. . . 1, 150 1, 100 1, 050 1, 000 Aug. 2000 Dec. 2000 Apr. 2001 Aug. 2001 Dec. 2001

Figure 10 d The Fed in Action: 2001 (d) Federal Funds Rate Percent which caused the interest rate to drop. 6. 0 5. 0 4. 0 3. 0 2. 0 Aug. 2000 Dec. 2000 Apr. 2001 Aug. 2001 Dec. 2001