(Transcript of audio with descriptions. Transcript includes narrator headings and description headings of the visual content)
(Speaker)
This chapter introduced you to the liquidity preference framework and monetary policy. At this time, you've probably noticed that we've introduced two interest rates. There was an interest rate that resulted from the liquidity preference controlled by the Federal Reserve, and an interest rate that equated the demand and supply of loanable funds. In this question, you were asked to analyze the differences between these interest rates.
(Description)
The following text is briefly written:
Contrast the short-run effects of an increase in the money supply on the interest rate to the long-run effects of an increase in the money supply on the interest rate. Which market determines the interest rate in the short run? Which market does so in the long run? What are the implications of your answers for the effectiveness of monetary policy in influencing real GDP in the short run and the long run?
(Speaker)
In the short run, the interest rate is determined through the liquidity preference market.
(Description)
The coordinate plane with the horizontal x-axis and the vertical y-axis is briefly drawn. The horizontal axis is labeled as Quantity of Money. The vertical axis is labeled as Interest rate.
Point, M subscript 1, is labeled on the x-axis. Point, r subscript 1, is labeled on the y-axis.
A straight line sloping downward from the left upper corner to the right lower corner of the graph is drawn. Another straight line parallel to the y-axis, extending from point, M subscript 1, is drawn. Two lines intersect at point with coordinates, M subscript 1, and, r subscript 1.
A dotted line parallel to the x-axis, extending from point, r subscript 1, is drawn. It intersects with the previous two lines at point with coordinates, M subscript 1, and, r subscript 1.
(Speaker)
The short-run equilibrium interest rate is determined where money demands equals money supply. An increase in the money supply will lead to a fall in the interest rate in the money market. The fall in the interest rate will lead to an increase in real GDP, followed by an increase in savings through the multiplier process.
(Description)
Two coordinate planes with the horizontal x-axis and the vertical y-axis are briefly drawn.
For the left coordinate plane, the horizontal axis is labeled as Quantity of Money. The vertical axis is labeled as Interest rate.
For the right coordinate plane, the horizontal axis is labeled as Quantity of loanable funds. The vertical axis is labeled as Interest rate.
On the left coordinate plane, point, M subscript 1, is labeled on the x-axis. Point, r subscript 1, is labeled on the y-axis.
A straight line sloping downward from the left upper corner to the right lower corner of the graph is drawn. Another straight line parallel to the y-axis, extending from point, M subscript 1, is drawn. Two line intersect at point with coordinates, M subscript 1, and, r subscript 1.
A dotted line parallel to the x-axis, extending from point, r subscript 1, is drawn. It intersects with the previous two lines at point with coordinates, M subscript 1, and, r subscript 1.
On the right coordinate plane, Point, Q subscript 1, is labeled on the x-axis. Point, r subscript 1, is labeled on the y-axis.
A straight line sloping downwards from the left upper corner to the right lower corner of the graph is drawn. It is labeled as D. Another straight line sloping upwards from the left lower corner to the right upper corner of the graph is drawn. It is labeled as S subscript 1. Two lines intersect at point with coordinates, Q subscript 1, and, r subscript 1.
A dotted line parallel to the x-axis, extending from point, r subscript 1, is drawn. Another dotted line parallel to the y-axis, extending from point, Q subscript 1, is drawn. These dotted lines intersect at a right angle at point with coordinates, Q subscript 1, and, r subscript 1.
The following text is briefly written below the graphs:
An increase in the money supply lowers the interest rate, increases real GDP and household saving.
(Speaker)
The increase in savings will increase the supply of loanable funds, leading to a fall in the interest rate in the loanable funds market as well.
(Description)
On the left graph, point, M subscript 2, is labeled on the x-axis, so that the value of, M subscript 2, is larger than the value of, M subscript 1. Point, r subscript 2, is labeled on the y-axis, so that the value of, r subscript 2, is less than the value of, r subscript 1. A down arrow next to points, r subscript 1, and, r subscript 2, is drawn.
A straight line parallel to the y-axis, extending from point, M subscript 1, shifts to the right while retaining the same slope. The new line extends from point, M subscript 2. It intersects with the line sloping downward at point with coordinates, M subscript 2, and, r subscript 2.
A dotted line parallel to the x-axis, extending from point, r subscript 2, is drawn. It intersects with the line parallel to the y-axis, extending from point, M subscript 2, and line sloping downwards.
2 right arrows are drawn between lines parallel to the y-axis.
On the right graph, Q subscript 2, is labeled on the x-axis, so that the value of, Q subscript 2, is larger than the value of, Q subscript 1. Point, r subscript 2, is labeled on the y-axis, so that the value of, r subscript 2, is less than the value of, r subscript 1. A down arrow next to points, r subscript 1, and, r subscript 2, is drawn.
A straight line sloping upwards from the left lower corner to the right upper corner of the graph shifts to the right while retaining the same slope. The new line is labeled as S subscript 1. It intersects with the line, D, at point with coordinates, Q subscript 2, and, r subscript 2.
A dotted line parallel to the x-axis, extending from point, r subscript 2, is drawn. Another dotted line parallel to the y-axis, extending from point, Q subscript 2, is drawn. These dotted lines intersect at a right angle at point with coordinates, Q subscript 2, and, r subscript 2.
2 right arrows are drawn between lines, S, and, S subscript 1.
(Speaker)
So in the short run, an expansionary monetary policy will increase real GDP. Similarly, a contractionary monetary policy will reduce real GDP in the short run.
In the long run, real GDP cannot differ from potential output, which means the interest rate is determined in the loanable funds market.
(Description)
Two coordinate planes with the horizontal x-axis and the vertical y-axis are drawn.
For the left coordinate plane, the horizontal axis is labeled as Quantity of loanable funds. The vertical axis is labeled as Interest rate.
For the right coordinate plane, the horizontal axis is labeled as Real GDP. The vertical axis is labeled as Aggregate price level.
On the left coordinate plane, Point, Q subscript 1, is labeled on the x-axis. Point, r subscript 1, is labeled on the y-axis.
A straight line sloping downwards from the left upper corner to the right lower corner of the graph is drawn. It is labeled as D. Another straight line sloping upwards from the left lower corner to the right upper corner of the graph is drawn. It is labeled as S subscript 1. Two lines intersect at point with coordinates, Q subscript 1, and, r subscript 1.
A dotted line parallel to the x-axis, extending from point, r subscript 1, is drawn. Another dotted line parallel to the y-axis, extending from point, Q subscript 1, is drawn. These dotted lines intersect at a right angle at point with coordinates, Q subscript 1, and, r subscript 1.
On the right coordinate plane, Point, Y subscript 1 equals Y star, is labeled on the x-axis. Point, p subscript 1, is labeled on the y-axis.
A straight line sloping downwards from the left upper corner to the right lower corner of the graph is drawn. It is labeled as AD subscript 2. Another straight line sloping upwards from the left lower corner to the right upper corner of the graph is drawn. It is labeled as AS. The last straight line parallel to the y-axis, extending from point, Y subscript 1 equals Y star, is drawn. It is labeled as LRAS. Three lines intersect at point with coordinates, Y subscript 1 equals Y star, and, p subscript 1.
A dotted line parallel to the x-axis, extending from point, p subscript 1, is drawn. It intersects with the previous 3 straight lines at their intersection point.
(Speaker)
The long-run equilibrium interest rate equates the supply of loanable funds and the demand for loanable funds that arise when aggregate output is equal to potential output.
In the long run, an increase in the monetary supply will ultimately result in an increase in nominal wages.
The short-run aggregate supply curve will shift leftward and real GDP will fall.
(Description)
On the left graph, point Q subscript 2, is labeled on the x-axis, so that the value of, Q subscript 2, is larger than the value of, Q subscript 1. Point, r subscript 2, is labeled on the y-axis, so that the value of, r subscript 2, is less than the value of, r subscript 1.
The line, S subscript 1, shifts to the right while retaining the same slope. The new line is labeled as S subscript 1. The old line is now labeled as S subscript 2. It intersects with the line, D, at point with coordinates, Q subscript 2, and, r subscript 2. An up arrow next to points, r subscript 1, and, r subscript 2, is drawn.
2 left arrows are drawn between lines, S subscript 1, and, S subscript 2.
A dotted line parallel to the x-axis, extending from point, r subscript 2, is drawn. Another dotted line parallel to the y-axis, extending from point, Q subscript 2, is drawn. These dotted lines intersect at a right angle at point with coordinates, Q subscript 2, and, r subscript 2.
On the right graph, point, p subscript 1, is now labeled as, p subscript 2. Point, p subscript 1, is labeled on the y-axis, so that so that the value of, p subscript 2, is larger than the value of, p subscript 1.
The line, AS subscript 1, shifts to the right while retaining the same slope. The new line is labeled as AS subscript 1. The old line is now labeled as AS subscript 2. Line, AS subscript 1, intersects with the lines, AD subscript 2, and, LRAS, at point with coordinates, Y subscript 1 equals Y star, and, p subscript 1.
A dotted line parallel to the x-axis, extending from point, p subscript 1, is drawn. It intersects with lines, AS subscript 1, and, LRAS, at their intersection point.
2 left arrows are drawn between lines, AS subscript 1, and, AS subscript 2.
(Speaker)
As real GDP falls, savings will fall as well, leading to a reduction in the supply of loanable funds and a rise in the interest rate. This process will continue until aggregate output is equal to potential output. The interest rate in the money market will also rise as a higher aggregate price level in the long run leads to an increase in demand for money