Principles of Macroeconomics / Unit 12 MAC 1113 worked example, 60 to 90 seconds
Working a Change in the Money Market
The idea
Given a change in money demand or supply, find the new interest rate and trace what follows. Work it in four steps: what moved and which way, what happens to the interest rate, what that does to investment and net exports, and where aggregate demand ends up. The bond market moves alongside, and the two must agree.
In practice
Start with a supply of 900 billion and an equilibrium rate of 4 percent. The central bank buys bonds and supply rises to 1,000. At 4 percent people do not want to hold the extra money, so they buy bonds; bond prices rise, and a higher bond price is a lower interest rate. The rate falls until the quantity demanded reaches 1,000, say to 3 percent. Lower rates raise investment and durable consumption, and they lower the exchange rate, which raises net exports. Aggregate demand shifts right by the multiplier times those initial changes. Real GDP and the price level rise.
Where people slip
The money market and the bond market are two views of one adjustment, not two events. When people hold less money they are holding more bonds, so the rate that clears one clears the other. Working them as separate steps that might disagree is the error to avoid.
Your place on the trail
Every lesson rests on earlier ones and opens later ones. Tap any to jump.
Something wrong in this lesson? Flag it · Sources for Principles of Macroeconomics