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Chapter Twenty Seven
Money Demand, the
Equilibrium Interest
Rate, and Monetary
Policy
Transactions Motive
The transactions motive refers to
the main reason people hold
money… to buy things.
The Nonsynchronization of
Income and Spending
Spending,
Income
Income
Spending
March 1st
April 1st
May 1st
June 1st
Time
The Demand Curve for Money
Balances
Interest
Rate
10%
8%
6%
Md
Money, M
Speculation Motive
Individuals may choose to hold bonds
over money: Because the market value
of interest-bearing bonds is inversely
related to the interest rate, investors may
wish to hold bonds when the interest
rates are high with the hope of selling
them when interest rates fall.
Total Demand for Money
Interest
Rate
10%
8%
6%
Md
M d1
M d2
Money, M
Determinants of Money
Demand
1. The interest rate
2. The dollar volume of transactions
- Aggregate output
- The price level
An increase in aggregate output (Y) will shift the
money demand curve to the right...
Interest
Rate
10%
8%
6%
Md (Y2)
Md (Y1)
M d1
M d2
Money, M
The Equilibrium Interest Rate
Interest
Rate
MS
Excess supply of
money
Equilibrium
Point
Excess demand
for money
r1
r*
r2
Md
M d1
M d2
Money, M
The effect of an increase in the supply of
money on the interest rate...
Interest
Rate
M0 S
M1 S
Excess supply of
money at M1s
14
8
Md
M d0
M d1
Money, M
An Increase in Y Shifts the
Money Demand Curve to
the Right
The effect of an increase in income on
the interest rate...
Interest
Rate
14
Md (Y2)
7
Md (Y1)
M d1
M d2
Money, M
•An Increase in the Price Level
is lake an Increase in Y in that
Both Events Increase the
Demand for Money.
•The Result is an Increase
in the Equilibrium Interest
Rate
Monetary Policy
Tight Monetary Policy is when the
Fed uses policies that contract the
money supply in an effort to restrain
the economy.
Easy Monetary Policy is when the
Fed uses policies that expand the
money supply in an effort to
stimulate the economy.
Review Terms & Concepts
 Easy monetary policy
 Interest
 Interest rate
 Monetary policy
 Nonsynchronization of income and spending
 Speculation motive
 Tight monetary policy
 Transaction motive