From my understanding, when the money supply curve shifts to the right, interest rates go down, it follows that the price level decreases and the prices should go down?
Thanks in advance.
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$\begingroup$ Try thinking intuitively. More money in the economy for same amount of goods will increase prices for those goods. $\endgroup$– RumiCommented Nov 14, 2020 at 10:53
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$\begingroup$ Your question presupposes that central banks directly control the money supply. This is not true at all. $\endgroup$– MickCommented May 15, 2021 at 8:19
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2 Answers
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Price levels are not necessarily linked to interest rates, especially real rates.
Speaking strictly from an IS-LM standpoint, an expansionary monetary policy will increase the real money supply and depress interest rates, holding output constant. This will cause a rightward shift in the LM curve; holding money demand constant, the relative value of currency must fall.
Speaking practically, lower rates reduce the hurdle rate for investments and thus promote asset inflation. Further, the lower rates will also find their way into consumer credit, increasing purchasing power among consumers and thus driving up prices of consumer goods. Mind that the former precedes the latter by a good couple years.
Hope that answered your question.
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More money chasing the same amount of goods causes prices to rise until all demand is satisfied at the higher price.
