The following diagram represents the money market in the United States, which is currently in equilibrium, as indicated by the grey star.
New Curve
New Equilibrium
0.6
0.7
0.8
0.9
1.0
1.1
1.2
1.3
6.0
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
INTEREST RATE (Percent)
QUANTITY OF MONEY (Trillions of dollars)
Money Supply
Money Demand
Suppose the Federal Reserve (the Fed) announces that it is lowering its target interest rate by 25 basis points, or 0.25%. It would achieve this by the . Use the green line (triangle symbols) on the preceding graph to illustrate the effects of this policy. Place the black point (plus symbol) on the graph to indicate the new equilibrium interest rate and quantity of money.
The sequence of events that results in a new equilibrium interest rate, after the Fed makes the change you selected, may be described as follows: Because there is money in the financial system, the quantity of interest-bearing financial assets (such as bonds) demanded , which means that bond issuers sell bonds. This process continues until the new equilibrium interest rate is achieved.
Suppose the Federal Reserve (the Fed) announces that it is lowering its target interest rate by 25 basis points, or 0.25%. It would achieve this by increasing the money supply.
To illustrate the effects of this policy, we will shift the money supply curve to the right. This can be done by placing the green line (triangle symbols) on the graph. The new equilibrium interest rate and quantity of money can be indicated by placing the black point (plus symbol) on the graph.
The sequence of events that results in a new equilibrium interest rate, after the Fed makes the change of increasing the money supply, may be described as follows:
Because there is more money in the financial system, the quantity of interest-bearing financial assets (such as bonds) demanded decreases, which means that bond issuers need to sell more bonds. This process continues until the new equilibrium interest rate is achieved. As a result, the interest rate decreases, while the quantity of money increases.