Question

Use the money demand and money supply model to show the money market in equilibrium with an interest rate of 5 percent and the quantity of money of $800 billion. Suppose the Federal Reserve increases the money supply to $850 billion. At the previous equilibrium interest rate of 5 percent, will households and firms now be holding more money or less money than they want to hold, and will they be buying or selling short-term financial assets? At the new equilibrium interest rate, households and firms will desire to hold the entire $850 billion of the money supply. What causes households and firms to want to hold the additional $50 billion of the money supply?

Answer 1