Answered: The following diagram represents the…

ECON MACRO

5th Edition

ISBN:9781337000529

Author:William A. McEachern

Publisher:William A. McEachern

Chapter15: Monetary Theory And Policy

Section: Chapter Questions

Problem 1.2P

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Equilibrium and disequilibrium in the money market

The following diagram represents the money market in the United States, which is currently in equilibrium, as indicated by the grey star.

Suppose the Federal Reserve (the Fed) announces that it is raising its target interest rate by 25 basis points, or 0.25%. It would achieve this by

decrease

increase

the

money supply

money demand

. Use the green line (triangle symbols) on the preceding graph to illustrate the effects of this policy. Place the black point (plus symbol) on the graph to indicate the new equilibrium interest rate and quantity of money.

The sequence of events that results in a new equilibrium interest rate, after the Fed makes the change you selected, may be described as follows: Because there is

less

money in the financial system, the quantity of money demanded

increases

decreases

, which means that bond issuers

can issue bonds at lower interest rates and still

must raise the interest they pay

sell bonds. This process continues until the new equilibrium interest rate is achieved.

Money Supply
6.0
5.5
New Curve
Money Demand
5.0
4.5
New Equilibrium
4.0
3.5
3.0
2.5
2.0
0.6
0.7
0.8
0.9
1.0
1.1
1.2
1.3
QUANTITY OF MONEY (Trillions of dollars)
INTEREST RATE (Percent)

Definition Definition Financial market that deals in securities or assets that are short-term in nature. The money market is responsible for keeping up the liquidity of the businesses and the organizations. These securities are usually held for a period of 12 months or less and are issued by institutions that require cash or funds for their short-term cash flow requirements. The money market is regulated by the federal government.

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