Chapter 26 - Money Demand
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There are 3 tools of Monetary Policy:
1) s in the rr,
2) s in the Discount Rate
3) OMO.
• Since the Fed controls the Ms, we take it to be
exogenous, implying the Ms curve is a vertical
line.
• Equilibrium r is determined by both the Ms and
the economy’s money demand (Md).
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Money Demand
• Md Curve – shows the relationship between the
Quantity of Money Demanded and the r.
• This implies that the Quantity of Md is a function
of r.
• Quantity of Md is a negative function of r.
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Money Demand cont.
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Money Demand Curve
• Since Md is a function of the r, changes in r will
lead to a movement along the Md curve.
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2 Factors that Shift the Md curve
• 1) Changes in the Price Level (P)
• An increase in Prices implies you need more
Money to buy the same goods you were buying
yesterday.
• Therefore, there will be an increase in your Md.
• An increase in Md is represented by the Md curve5
shifting to the right.
Money Demand Shift
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Factors that Shift Md cont.
• 2) Changes in Income (Y)
• When Income rises it leads to an increase in
Consumption (C).
• In order to purchase more goods and services you
need Money.
• Therefore, an increase in Y leads to an increase in
Md, and the Md curve will shift to the right.
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The Money Market
• The Ms curve and the Md curve together
represent the Money Market.
• The Equilibrium r (r*) is determined at that r
where Quantity of Ms is exactly equal to
Quantity of Md.
• Shifts in either of these curves will change r*.
• Shifts in Ms come from Monetary Policy, and
shifts in Md come from changes in P and/or Y.
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The Money Market
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Money Market Example #1
• Suppose the Fed buys bonds from commercial
banks.
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Money Market Example #2
• Suppose the economy goes into a recession
implying a decrease in Y.
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Money Market Example #3
• Suppose the Fed increases the Discount Rate.
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Money Market Example #4
• Suppose there is an increase in the CPI.
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Summary of Monetary Policy and the
Money Market
• An increase in Ms can occur from:
• 1) Decrease in rr.
• 2) Decrease in the Discount Rate.
• 3) The Central Bank’s purchase of bonds from the
public.
• The above three actions will cause the Ms Curve
to shift right, which will lead to a decrease in r.
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Summary of Monetary Policy cont.
• A decrease in Ms can occur from:
• 1) An increase in rr.
• 2) An increase in the Discount Rate.
• 3) The Central Bank’s sale of bonds to the public.
• The above three actions will cause the Ms Curve
to shift left, which will lead to a increase in r.
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Summary of Md and the Money Market
• 1) An increase in P causes an increase in Md,
which will cause the Md Curve to shift right,
leading to an increase in r.
• 2) A decrease in P causes an decrease in Md,
which will cause the Md Curve to shift left,
leading to a decrease in r.
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Summary of Md cont.
• 3) An increase in Income causes an increase in
Md, which will cause the Md Curve to shift right,
leading to an increase in r.
• 4) A decrease in Income causes an decrease in Md,
which will cause the Md Curve to shift left,
leading to a decrease in r.
• Changes in r leads to changes in quantity of Md,
represented by movement along the Md curve.
Changes in r will NOT shift Md!
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