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Is it true that when the overall money supply decreases, that the demand for money decreases and the demand for bonds and securities both increase?
I understand that to increase the money supply, the central bank uses cash reserves to pay for bonds. I’ve been thinking about this for a while, but does this lead to an increase in demand for the bonds and a decrease in demand for money or is it the other way around?
The quantity of money supplied has nothing to do with either the demand function of money or the demand function for bonds.
If there are changes in monetary policy such that the quantity of money supplied in equilibrium changes, then the quantity of money supplied clearly increases. In most models it is assumed that demand for money is decreasing in the nominal interest rate, so one way to achieve an increase in demand for money is to decrease the nominal interest rate. As people will hold more of their wealth in money, they will hold less in bonds.
