Question

Targeting the money supply or the interest rate The following graph shows an increase in the demand for money from 2013 (MD2013) to 2014 (MD2014) caused by an increase in the price level. The initial equilibrium interest rate in 2013 was . Now suppose the Bank of Canada chooses not to alter the money supply between 2013 and 2014. On the following graph, use the grey point (star symbol) to illustrate the equilibrium interest rate and quantity of money that would result from this lack of intervention. No Intervention New MS Curve With Intervention 0.9 1.0 1.1 1.2 1.3 1.4 1.5 6.75 6.50 6.25 6.00 5.75 5.50 5.25 5.00 4.75 NOMINAL INTEREST RATE (Percent) QUANTITY OF MONEY (Trillions of dollars) MD 2013 MD 2014 Money Supply Suppose the Bank of Canada wants to keep 2014 interest rates at their 2013 level. On the previous graph, place the green line (triangle symbol) to indicate the new money supply curve if the Bank of Canada follows this policy. Then use the black point (plus symbol) to indicate the equilibrium interest rate and quantity of money in this case. In part because , most central banks set monetary policy aimed at targeting a specific .

Answer 1

In the market for loanable bank funds, an expansionary monetary policy lowers the interest rate and increases the quantity of funds loaned, while a contractionary monetary policy raises the interest rate and decreases the quantity of funds loaned.

Step-by-step explanation:

In the market for loanable bank funds, an expansionary monetary policy shifts the supply of loanable funds to the right, leading to a lower interest rate and a higher quantity of funds loaned. Conversely, a contractionary monetary policy shifts the supply of loanable funds to the left, resulting in a higher interest rate and a lower quantity of funds loaned. The Bank of Canada's decision not to alter the money supply between 2013 and 2014 would mean that the money supply curve remains unchanged. The equilibrium interest rate and quantity of money resulting from this lack of intervention can be represented by the grey point (star symbol) on the graph.

Answer 2

Monetary policy affects interest rates through shifts in the supply of loanable bank funds; expansionary policy decreases rates and increases funds loaned, while contractionary policy does the opposite.

Step-by-step explanation:

The effect of monetary policy on interest rates can be understood through the market for loanable bank funds. When the central bank employs an expansionary monetary policy, it increases the supply of money, which shifts the supply curve of loanable funds to the right. This action lowers the equilibrium interest rate and increases the quantity of funds loaned. For example, a shift from the original supply curve (So) to a new supply curve (S₁) can decrease the interest rate from 8% to 6% while increasing the quantity loaned from $10 billion to $14 billion. Conversely, a contractionary monetary policy results in reducing the money supply, shifting the supply curve to the left, leading to a higher equilibrium interest rate and a decreased quantity of funds loaned. An example here would be a shift from the original supply curve (So) to a new supply curve (S₂), raising the interest rate from 8% to 10% and reducing the quantity loaned to $8 billion.