(Transcript of audio with descriptions. Transcript includes narrator headings and description headings of the visual content)
(Speaker)
Next, we are going to explore the relationship between a change in the interest rate and aggregate demand. Again we show our liquidity preference framework, and as we discussed previously, the Federal Reserve is able to increase the money supply and lower the interest rate.
(Description)
Because of the economic slowdown associated with the 2007 - 2009 recession, the Federal Open Market Committee of the Federal Reserve, between September 18, 2007 and December 16, 2008, lowered the federal funds rate in a series of steps from a high of 5.25 percent to a rate between zero and 0.25 percent. The idea was to provide a boost to the economy by increasing aggregate demand. Explain why the reduction in the interest rate causes aggregate demand to increase in the short run. On the Figure there are graphs of money supply and demand. Horizontal axis corresponds to the quantity of money. Vertical axis corresponds to interest rate (r). Two straight lines are plotted with demand line passing through points on two axes at the same distance from origin and supply line parallel to the interest rate axis at M1. Lines intersect at point (M asterisk, r asterisk).
(Speaker)
As the interest rate decreases, firms will find more investments profitable and households will choose to purchase more big-ticket items like homes and new cars.
(Description)
The lower interest rate will increase planned investment spending. On the Figure there are graphs of money supply and demand. Two straight lines are plotted with demand line passing through points at the same distance from origin on the axis and supply line parallel to the interest rate axis at M1. Lines intersect at point (M asterisk, r asterisk). Additional vertical line on the right side of the original supply line is plotted. New intersection point for supply and demand lines is (M2,r2). Arrows indicate the right shift of the money supply line.
(Speaker)
The lower interest rate will increase autonomous consumption and planned investment spending.
(Description)
An increase in planned investment spending will shift aggregate demand to the right. On the Figure there are graphs of aggregate supply and demand. Horizontal axis corresponds to real GDP. Vertical axis corresponds to aggregate price level. Two straight lines are plotted with aggregate demand line AD1 passing through points on two axes at the same distance from the origin and supply line passing through the origin and bisecting the quadrant. Lines intersect at point (Y1,p1). Additional line AD2 parallel to AD1 and shifted to the right is plotted. New intersection point for aggregate supply AS and aggregate demand AD2 lines is (Y2,p2). Arrows indicate the right shift of the aggregate demand line.
(Speaker)
Both of these will shift aggregate demand to the right. This will cause real GDP and the aggregate price level to increase.