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MODULE 31
Monetary Policy and the Interest Rate
In this Module, you will learn to:
Describe how the Federal Reserve implements monetary policy, moving the interest rate to affect aggregate output
Explain why monetary policy is the main tool for stabilizing the economy
In Modules 28 and 29 we developed models of the money market and the loanable funds market. We also saw how these two markets are consistent and related. In the short run, the interest rate is determined in the money market and the loanable funds market adjusts in response to changes in the money market. However, in the long run, the interest rate is determined by matching the supply and demand of loanable funds that arise when real GDP equals potential output. Now we are ready to use these models to explain how the Federal Reserve can use monetary policy to stabilize the economy in the short run.