Answer to Question #211850 in Macroeconomics for Muhammad radhi

Question

Explain how each of the following developments would affect the supply of money, the demand for money, and the interest rate. Illustrate your answer with diagrams. 

a) BNM’s securities traders buy securities in open-market operations. 

b) An increase in credit-card availability reduces the cash people hold.

c) BNM reduces banks’ reserve requirements. 

d) Households decide to hold more money to use for holiday shopping. 

e) A wave of optimism boosts business investment and expands aggregate demand. 

Answer 1

Solution:

a.). BNM’s securities traders buy securities in open-market operations:

This will lead to an increase in money supply, making money less valuable and reducing the interest rates in the money market since the security prices will increase.

 

This is displayed by the below graph:

 

 

b.). An increase in credit-card availability reduces the cash people hold:

This will lead to a decrease in the demand for money due to the higher usage of credit cards which provides interest-free loans, hence people will prefer not to hold cash in hand for performing transactions. Similarly, there will be an increase in the money supply, which will ultimately push down the interest rate.

 

This is displayed by the below graph:

 

 

c.). BNM reduces banks’ reserve requirements.

 This will increase the money supply in the economy since banks will be able to loan out more money, which increases the overall money supply. Ultimately this will lead to a decrease in the interest rate.

This is displayed by the below graph:

d.). Households decide to hold more money to use for holiday shopping:

This will lead to a decrease in the money supply since there will be more leakage in the lending process as households tend to hold more cash. There will be an increase in money demand which will ultimately increase the interest rate.

 

This is displayed by the below graph:

 

 

e.). A wave of optimism boosts business investment and expands aggregate demand:

This will increase the demand for money as companies demand more money for investment since they expect more returns on their investment. This will ultimately increase the interest rate.

 

This is displayed by the below graph: