Question

Explain how each of the following developments would affect the supply of

money, the demand for money, and the interest rate. Use diagrams to
illustrate your answers.
a. The Fed’s bond traders buy bonds in open-market operations.
b. An increase in credit-card availability reduces the amount of cash
people want to hold.
c. The Fed reduces reserve requirements.
d. Households decide to hold more money to use for holiday shopping.
e. A wave of optimism boosts business investment and expands
aggregate demand.

Answer 1

a. Fed's bond purchase increases money supply, lowers interest rates. Demand for money may decrease, illustrated by the liquidity preference theory.

b. Increased credit-card availability reduces money demand, potentially lowering interest rates due to decreased need for cash holdings.

c. Fed reducing reserve requirements increases money supply, potentially lowering interest rates by injecting more liquidity into the market.

d. Household preference for more cash increases money demand, potentially raising interest rates due to higher demand for liquidity.

e. Optimism boosts business investment, increasing demand for loans and money. Money supply may rise, potentially raising interest rates.

The entire amount of cash and other liquid assets in an economy on the measurement date is called the money supply.

All cash on hand as well as bank deposits that account holders may quickly convert to cash are included in the money supply.

Therefore, high-powered money, the currency ratio, the needed reserve ratio, the market interest rate, and the bank rate all influence the amount of money in circulation.