Question

What determines the demand for money in the economy? How is it related to the liquidity preference money of interest rates? Given this relationship, explain how monetary policy can affect the demand of as well as supply for money through open market operations and setting target federal funds market interest rates.

Answer 1

The concept of demand and supply for money different from the product.The following the factors which determine the demand for money.The following are the liquidity preference for money

• Transaction motive for day to day activities when there is boom situation economy people required more money
• The precautionary motive to meet unforeseen events example Business man keeps the money to solve any risk in future.
• The speculative motive people keep the money for speculating activities by changes in interest rate.

The supply of money depends completely on central bank decisions the supply of money increase and decreased based on expansionary and contractionary monetary policy

The open market operation is the tool of monetary policy in regulating the supply of money increase the open market operation commercial banks required buy these government securities hence excess liquidity of the commercial banks will be reduced and supply of money reduced during inflationary time.