Principles of Macroeconomics / Unit 12 MAC 1111 worked example, 60 to 90 seconds
What Shifts Money Demand
The idea
Decide whether an event moves along the money demand curve or shifts it. The test is the same one unit two established: if the interest rate changed, the movement is along the curve; if anything else changed, the curve shifts. Five things shift it: real GDP, the price level, expectations, transfer costs and preferences.
In practice
Real GDP rises, so more transactions need financing and demand shifts right. The price level rises, so a given basket takes more money and demand shifts right. People come to expect bond prices to fall, so speculative demand rises and the curve shifts right. Transferring between accounts becomes cheaper, so people economise on money and the curve shifts left. Households become more cautious about risk and the curve shifts right. Now contrast all five with a central bank action that lowers the interest rate: that is a movement along the curve, and the curve has not moved at all.
Where people slip
Expectations here can be self-confirming. If enough people expect bond prices to fall and sell bonds to hold money, the selling itself pushes bond prices down. That is a feature of asset markets rather than a flaw in the model, and it means the curve's position depends partly on beliefs about its own position.
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