The Demand for Money

7.2 How the Supply of Money and the Demand for Money. Determine the What Happens When There is a Change in the Demand for Money? A Simple Model

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The Demand for Money
In the last chapter we saw how the Federal Reserve can change the quantity of money in existence at will. In this chapter we will see how a change in the quantity of money causes interest rates to rise or fall. Since interest rates are a key variable in decisions to buy or invest, the ability to move interest rates gives the Fed a powerful lever to move the economy. That is why it is worth enduring some moderately technical discussion of the demand for money.
We use the familiar supply and demand model of economics to understand how changes in the quantity of money cause interest rates to move. The supply of money is the quantity of money, currency and bank deposits, set by the Fed. That is the number of dollars available to be held in wallets and bank accounts. The amount of money that people desire to hold is the demand for money. Since every dollar is held voluntarily, the quantity of money supplied by the Fed must be equal to the quantity demanded by money holders. As always, the demand for a good or service depends in part on its price or cost.

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