The influence of Monetary

on Aggregate Demand

Group 7
Nguyễn Thị Thùy Dương
VŨ Thị Diệu Huyền
Nguyễn Thị Tâm
Nguyễn Phương Linh
Nguyễn Mậu Duy
Nguyễn Thị Kim Anh
Yana Tumash
Monetary Policy Influences Aggregate Demand

 Aggregate-demand curve slopes downward:

- The wealth effect
- The interest-rate effect
- The exchange-rate effect
 Occur simultaneously:
- When price level falls
Quantity of goods and services demanded increa
ses
- When price level rises
Quantity of goods and services demanded decre
ases
Monetary Policy Influences Aggregate Demand

 For U.S. economy

 The wealth effect
- Least important
- Money holdings – a small part of household
wealth
 The exchange-rate effect
- Not large
- Exports and imports – small fraction of GDP
 The interest-rate effect
- The most important
Monetary Policy Influences Aggregate Demand

 The theory of liquidity preference

Keynes’s theory
 Interest rate adjusts:
To bring money supply and money demand into bala
nce
 Nominal interest rate
 Real interest rate
Monetary Policy Influences Aggregate Demand
 The theory of liquidity preference
Money supply
- Controlled by the Fed
- Quantity of money supplied
Fixed by Fed policy
Doesn’t vary with interest rate
 Money demand
- Money – most liquid asset
- Interest rate – opportunity cost of holding money
- Money demand curve – downward sloping
 Equilibrium in the money market
- Equilibrium interest rate
- Quantity of money demanded = quantity of money sup
plied
Monetary Policy Influences Aggregate Demand
 The theory of liquidity preference
If interest rate > equilibrium If interest rate <equilibrium

- Quantity of money people want to Quantity of money people want to

hold hold
Less than quantity supplied More than quantity supplied

- People holding the surplus - People - increase their holdings of

Buy interest-bearing assets money
Sell - interest-bearing assets
- Lowers the interest rate - Increase interest rates

- People - more willing to hold money

- Until: equilibrium - Until: equilibrium

Monetary Policy Influences Aggregate Demand

 The downward slope of the aggregate-demand curve

 A higher price level
– Raises money demand
 Higher money demand
– Leads to a higher interest rate
 A higher interest rate
– Reduces the quantity of goods and services
demanded
 Monetary Policy Influences Aggregate Demand
The money market and the slope of the
aggregate-demand curve
(a) The Money Market (b) The Aggregate-Demand Curve
Interest Price
rate Money 2. . . . increases the level 1. An increase
supply demand for money . . . in the price level . . .
4. . . . which in turn
3. . . . which increases reduces the quantity of
r2 equilibrium interest rate . . . P2 goods and services
demanded.

Money demand at
r1 P1
price level P2, MD2

Aggregate
Money demand at
demand
price level P1, MD1

0 Quantity fixed Quantity 0 Y2 Y1 Quantity

by the Fed of money of output

An increase in the price level from P1 to P2 shifts the money-demand curve to the right, as in panel (a). This incr
ease in money demand causes the interest rate to rise from r1 to r2. Because the interest rate is the cost of borr
owing, the increase in the interest rate reduces the quantity of goods and services demanded from Y1 to Y2. Thi
s negative relationship between the price level and quantity demanded is represented with a downward-sloping
aggregate-demand curve, as in panel (b). 8
Monetary Policy Influences Aggregate Demand
 Changes in the money supply
 Aggregate-demand curve shifts
- Quantity of goods and services demanded changesFor a g
iven price level
 Monetary policy
- Shifts aggregate-demand curve
 Monetary policy: the Fed increases the money supply
- Money-supply curve shifts right
- Interest rate falls
- At any given price level
– Increase in quantity demanded of goods and services
- Aggregate-demand curve shifts right

9
 Monetary Policy Influences Aggregate Demand
 A monetary injection
(a) The Money Market (b) The Aggregate-Demand Curve
Interest Price
rate Money supply, level
MS1 MS2
1. When the Fed
increases the
r1 money supply . . .
P

r2

AD2
Money demand Aggregate
at price level P demand, AD1
0 Quantity 0 Y1 Y2 Quantity of output
2. . . . the equilibrium of money 3. . . . which increases the quantity of goods and
interest rate falls . . . services demanded at a given price level.
In panel (a), an increase in the money supply from MS1 to MS2 reduces the equilibrium interest r
ate from r1 to r2. Because the interest rate is the cost of borrowing, the fall in the interest rate rai
ses the quantity of goods and services demanded at a given price level from Y1 to Y2. Thus, in p
anel (b), the aggregate-demand curve shifts to the right from AD1 to AD2. 10
Monetary Policy Influences Aggregate Demand

 Changes in the money supply

Monetary policy: the Fed decreases the money supply
- Money-supply curve shifts left
- Interest rate increases
- At any given price level
Decrease in quantity demanded of goods and ser
vices
- Aggregate-demand curve shifts left
Monetary Policy Influences Aggregate Demand

 The role of interest-rate targets in Fed policy

 Federal funds rate
- Interest rate
- Banks charge one another
- For short-term loans
 The Fed
- Targets the federal funds rate
The FOMC – open-market operations
Adjust money supply
Monetary Policy Influences Aggregate Demand

 The role of interest-rate targets in Fed policy

 Changes in monetary policy
- Aimed at expanding aggregate demand
Increasing the money supply
Lowering the interest rate
 Changes in monetary policy
- Aimed at contracting aggregate demand
Decreasing the money supply
Raising the interest rate
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