Monetary Policy and the Interest Rate

Controlling the Supply of Money

Increasing the Money Supply: Effect on the Interest Rate

Interest rate, r

Quantity ofmoney

An increase in the money supply…

r1

r2

E1

MS1

1

MS2

2

MD

E2

…leads to a fall in the interest rate.

Monetary Policy and Aggregate Demand

Contractionary monetary policy causes the aggregate demand curve to shift to the left (from AD1 to AD3).

Expansionary monetary policy causes the aggregate demand curve to shift to the right (from AD1 to AD2).

AD2AD3 AD1

Aggregate Price Level

Real GDP