Money supply, demand and asset markets

Question 1

Is money demand increasing or decreasing in the interest rate? Why?

Answer 1

Money demand is decreasing in the real interest rate.

Higher interest rate means people would rather put money in nonmonetary assets rather than hold it.

Question 2

Is money demand increasing or decreasing in Y? Why?

Answer 2

Increasing in Y.

Higher Y means that you have more output so you need to conduct more transactions.

Question 3

Is money demand increasing or decreasing in πe? Why?

Answer 3

Decreasing in πe. Value of money is going down, you rather put your money in an interest earning account.

Question 4

Assuming that the Fed likes price stability, what would it do to the money supply when GDP increases, and why?

Answer 4

Increase in output will increase demand so prices adjust upwards (indeed, we know that inflation and employment/growth go together). If the Fed wants price stability then it will increase the money supply, since higher P means Ms/P decreases so Ms must increase for Ms/P to stay roughly the same.