12.3 How Money Affects Aggregate Demand Flashcards
What is monetary equilibrium?
monetary equilibrium—the theory of how interest rates are determined in the short run by the interaction of money demand and money supply.
What is the Monetary transmission mechanism?
The channels by which a change in the demand for or supply of money leads to a shift of the aggregate demand curve.
Monetary transmission mechanism—the chain of events that takes us from changes in the interest rate, through to changes in desired aggregate expenditure, to changes in real GDP and the price level.
Graph of Monetary equilibrium
Why is the money supply curve vertical?
The money supply curve is vertical, indicating that it is assumed to be independent of the interest rate.
What causes the money supply to increase or decrease (Shift right or left) ?
The money supply increases ( shifts to the right) if the central bank increases reserves in the banking system or if the commercial banks decide to lend out a larger fraction of those reserves.
The money supply decreases ( shifts to the left) if the central bank decreases reserves in the banking system or if the commercial banks decide to reduce their lending.
Why is the money demand curve downward sloping?
The money demand curve is downward sloping, indicating that firms and households decide to hold more money (and fewer bonds) when the interest rate falls.
When does the interest rate rise and fall?
The interest rate rises when there is an excess demand for money and falls when there is an excess supply of money.
What is Monetary equilibrium?
Monetary equilibrium
The situation in which the quantity of money demanded equals the quantity of money supplied.
What does interest rate represent in the money market?
In the money market, the interest rate is the “price” that adjusts to bring about equilibrium.
What can a single household or firm do when they would like to hold more or less money?
When a single household or firm finds that it would like to hold more money (and fewer bonds) it can sell some bonds and add the cash proceeds to its money holdings. If the preference instead is to hold less money, the household or firm can buy bonds. Such adjustments in money and bond holdings for an individual household or firm can easily be made and will have a negligible effect on the economy.
Consider a disequilibrium situation in which firms and households would like to adjust their portfolios by holding more money and fewer bonds.
Consider a disequilibrium in which firms and households would like to adjust their portfolios by holding less money and more bonds.
When does Monetary equilibrium occur?
Monetary equilibrium occurs when the interest rate is such that the quantity of money demanded equals the quantity of money supplied.
What is the liquidity preference theory or interest? What is portfolio balance?
The theory of interest-rate determination depicted in Figure 12-2 is often called the liquidity preference theory of interest.
This name reflects the fact that when there are only two financial assets, a demand to hold money (rather than bonds) is a demand for the more liquid of the two assets—a preference for liquidity.
The theory determines how the interest rate fluctuates in the short term as people seek to achieve portfolio balance, given fixed supplies of both money and bonds.
What are the three stages of the monetary transmission mechanism?