๐ Topic Summary
The money market is where the supply and demand for money determine the nominal interest rate. The supply of money is controlled by the central bank (like the Federal Reserve in the U.S.). Demand for money is influenced by factors like real GDP, price level, and general expectations. When the money supply changes, it shifts the supply curve, affecting the equilibrium interest rate. Changes in the interest rate impact investment, aggregate demand, and ultimately, real GDP and inflation.
๐๏ธ Part A: Vocabulary
Match each term with its correct definition:
| Term |
Definition |
| 1. Money Supply |
a. The interest rate banks charge each other for overnight lending of reserves. |
| 2. Money Demand |
b. Actions taken by the central bank to influence the money supply and credit conditions to stimulate or restrain economic activity. |
| 3. Federal Funds Rate |
c. The total amount of money in circulation in an economy. |
| 4. Discount Rate |
d. The desire of individuals and businesses to hold money for transactions, precautionary, and speculative purposes. |
| 5. Monetary Policy |
e. The interest rate at which commercial banks can borrow money directly from the Fed. |
(Answers: 1-c, 2-d, 3-a, 4-e, 5-b)
โ๏ธ Part B: Fill in the Blanks
Complete the following paragraph using the words provided: (increase, decrease, interest rate, money supply, aggregate demand)
When the Federal Reserve decides to ________ the ________, this typically leads to a ________ in the ________. A lower interest rate stimulates investment, which subsequently causes an ________ in ________.
(Answers: increase, money supply, decrease, interest rate, increase, aggregate demand)
๐ค Part C: Critical Thinking
Suppose the economy is in a recession. Explain how the Federal Reserve could use monetary policy to stimulate economic growth. Be sure to discuss the specific actions the Fed could take and how these actions would impact the money market, interest rates, investment, and aggregate demand.