Natural level as does the unemployment rate and the

natural level, as does the unemployment rate
and the price level is higher
 A decrease in velocity causes the AD curve to shift
to the left
 Real GDP falls; Price level falls
 Unemployment level rises as GDP falls
 The economy is in a recessionary gap
 In the short run a decrease in velocity lowers
Real GDP and increases unemployment rate
 In the long run, Real GDP returns to its natural
level, as does the unemployment rate
The Monetarist View of the Economy:
 Economy is self-regulating
 Changes in velocity and the money supply can change aggregate demand
 Changes in velocity and the money supply will change the price level and Real
GDP in the short run but only the price level in the long run
14 – 4: Money and Interest Rates
What Economic Variables Does a Change in the Money Supply Affect?
Supply of loans, Real GDP and Price Level
 Money and the Supply of Loans:
o When the Fed conducts an open market purchase, the supply of loans
rises
o When the Fed conducts an open market sale, the supply of loans falls
 Money and Real GDP :
o In the short run an increase in the money supply will increase price
level and Real GDP
o A decrease in the money supply produces a lower level of Real GDP
and lower price level
Changes in the money supply can affect…
 The supply of loans
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 Real GDP
 Price Level
 The expected inflation rate
The Money Supply, the Loanable Funds Market and Interest Rates:
 The demand for loanable funds is downward sloping
o Borrowers will borrow more funds as the interest rate
drops
 The supply for loanable funds is upward sloping
o Lenders will lend more funds as the interest rate
rises
 If there is a surplus of loanable funds, the interest rate falls
 If there is a shortage of loanable funds, the interest rate rises
 The supply of loans, Real GDP, the price level and the expected
inflation rate affect either the supply or demand side and in turn affect the
interest rate
Supply of Loans:
 A Fed open market purchase
increases reserves in the banking
system and therefore increases
the supply of loanable funds
 Interest rate declines
 Liquidity Effect: the change in
the interest rate due to a change
in the supply of loanable funds
Real GDP:
 As real GDP rises, individuals
become wealthier, and they tend to buy more bonds (extend more loans)
 The supply of loanable funds increases
 When Real GDP rises, corporations issue or
supply more bonds, thereby demanding
more loanable funds
 As Real GDP increases, both supply and
demand for loanable funds increases
 The interest rate rises
Income Effect: the change in interest rate due to a
change in Real GDP
The Price-Level Effect: The change in the interest rate due
to a change in the price level
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 With respect to the interest rate effect, when the price level rises, the
purchasing power of money falls
 People may therefore increase their demand for credit or loanable funds to
borrow the funds necessary to buy a fixed bundle of goods
Expectations Effect: the change in interest rate due to a change in expected
inflation rate
