The Demand for Money

The price of holding money balances is the

interest rate.
The interest rate is the opportunity cost of
holding money.
As the interest rate increases, the
opportunity cost of holding money
increases, and people choose to hold less
money.

Supply and Demand for Money

Equilibrium in the Money Supply

The money supply is not
exclusively determined by
the Fed because both the
banks and the public are
important players the
money supply process.
Equilibrium in the money
market exists when the
quantity demanded of
money equals the quantity
supplied.

Transmission Mechanisms
The impact that changes in
the money market have
on the goods and services
market and whether that
impact is direct or indirect;
and the routes and ripple
effects created in the
money market travel to
affect the goods and
services market are known
as the transmission
mechanism.

The Keynesian Transmission

Mechanism
The Money Market
The Investment Goods Market
The Goods and Services Market (AD-AS
Framework)
When the money supply increases, the Keynesian
transmission mechanism works as follows: an
increase in the money supply lowers the interest
rate, which causes investment to rise and the AD
curve to shift rightward. Real GDP increases and
the unemployment rate drops.

The Keynesian Transmission

Mechanism: Indirect

The Keynesian Mechanism May

Get Blocked
Some Keynesian economists believe that investment
is not always responsive to interest rates. The
Keynesian transmission mechanism would be shortcircuited in the investment goods market, and the
link between the money market and the goods and
services market would be broken.
Keynesians have sometimes argued that the demand
curve for money could become horizontal at some
low interest rate. This is called the Liquidity Trap.

Keynesian Transmission
Mechanisms
Because the Keynesian transmission mechanism is indirect, both
interest insensitive investment demand and the liquidity trap may occur.

The Keynesian View of Monetary Policy

Bond Prices and Interest Rates

As the price of a bond decreases, the actual interest
rate return, or simply the interest rate, increases.
The market interest rate is inversely related to the
price of old or existing bonds.
Consider the Liquidity Trap: the reason an increase
in the money supply does not result in an excess
supply of money at a low interest rate is that
individuals believe bond prices are so high that an
investment in bonds is likely to turn out to be a bad
deal.