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    Money Demand and the Equilibrium Interest Rate

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    State whether you agree or disagree with the following statements and explain why.
    a) When the real economy expands (Y rises), the demand for money expands. As a result, households hold more cash and the supply of money expands.
    b) Inflation, a rise in the price level, causes the demand for money to decline. Because inflation causes money to be worth less, households want to less of it.
    c) If the Fed buys bonds in the open market and at the same time we experience a recession, interest rates will no doubt rise.

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    Solution Preview

    (a) When the real economy expands (Y rises), the demand for money expands. As a result, households hold more cash and the supply of money expands.

    The first part is correct. Money demand does go up with rising output. However, for the second part of the statement to hold: that is, for households to hold more cash and the supply of money to expand ...

    Solution Summary

    Money Demand and the Equilibrium Interest Rates are assessed here.

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