1
$\begingroup$

Here is an example graph of Money Market Equilibrium

enter image description here

The chain effects when interest rate is 8% are :

Excess Demand for Money => So, People would sell Bonds => Bond Prices goes Down => Interest Rate Goes up to 10% to achieve Equilibrium

I am understanding the chain effects, But I am very confused in this thing.

Say, at the 8% rate of interest, Money Demand = $225

----> People want to hold $225 in their pockets

Now Money Supply as we know is fixed at $200

----> Only this much, i.e $200 is available in their Pockets

Then how is it that People can sell Bonds (Which will lead to Chain Effects) to get 225 in their Pockets?

Where is this extra 25 coming from if we only have $200 in currency in our economy?

Please enlighten me as I think, what am I am understanding the Demand for Money means and how it works has some holes in them.

Thanks in Advance

$\endgroup$

1 Answer 1

0
$\begingroup$

Always keep in mind that the total quantity of money in the economy is not altered by the attempts of individuals to change their own holdings of money.

The currency or checking account balance that one person uses to buy or sell a bond only passes into someone else's hands.

While any one economic agent can increase or decrease the quantity of money that they hold, all economic agents taken together cannot change the quantity of money that they hold because the quantity of money is fixed.

Currency and bank account balances can move from one agent to another, but only the Fed can change the total amount of money that everybody holds in aggregate.

$\endgroup$
1
  • $\begingroup$ If someone can please support this answer with a simple example involving numerical values, it would be of great help. Thanks $\endgroup$ 2 days ago

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.