Question

Explain how each of the following developments might affect the supply of money, the demand for money, and the nominal interest rate, if at all. Illustrate each answer with a diagram of the supply and demand for money.

a) The Fed’s bond traders buy bonds in an open market operation.

b) A bank panic hits the nation. People try to take all the money out of their checking accounts so they can hold it as cash.

c) Rising oil prices cause an increase in inflation.

Answer 1

a) if the Fed's bond traders buy bonds in an open market operations then the money supply in the Economy Increases and the demand for money in the economy remains unchanged and the nominal interest rate falls. This is shown in the diagram below:

b) A bank panic hits the nation. people try to take all the money out of their checking accounts so that they can hold as cash. This leads to an increase in the demand for money in the economy. The money supply remains unchanged and the nominal interest rate increases in the economy. This is shown in the diagram below:

c) an increase in inflation leads to an increase in the demand for money as people would try to hold more cash to buy the same amount of goods and services which now have become more expensive. So the demand for money in the economy increases. The money supply remains unchanged and the nominal interest rate increases. This is shown in the diagram below: