ECON-1007EL Study Guide - Final Guide: Monetary Transmission Mechanism, Aggregate Demand, Commercial Bank
22 May 2018
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Monetary Equilibrium, Monetary Transmission Mechanism, and Monetary Policy
In macroeconomics, the monetary transmission mechanism is the process that allows for
a change in either demand for money or the money supply which leads to a shift in the aggregate
demand curve. This process has many steps but relies on three large ideas that create the large-
scale production. The first stage of the monetary transmission mechanism is the change in supply
and demand of money, which allows for a change in the equilibrium interest rate in the short run.
The change in equilibrium interest rate can be divided into four main sections: a positive change
in the money supply, a negative change in the money supply, a positive change in the money
demand, and a negative change in the money demand.
The positive change in the money supply has many different outcomes of the economy in
the short run. This increase in money supply from a monetary equilibrium due to either the
increase in reserves by the central bank or the increase in the commercial bank lending out their
existing reserves. This change causes an excess in the money supply since more money is in
circulation. The firms and households buy the bonds since there is a increase in money supply to
buy them. In doing this, bond prices increase due to the increased demand of bonds which, in
contrast, forces equilibrium interest rates down due to the lack of necessity to lend with higher
rates.
The positive change in demand for money has opposite effects than a positive change in
money supply in the short run. At a given interest rate, the demand for money is in excess,
possibly due to an increase in real GDP, an increase in the price level, or the desire to hold
money instead of investing in bonds. Since there is a demand for money, firms and households
sell their bonds to fulfill the demand for money. In doing this, more bonds are available so the
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Document Summary
Monetary equilibrium, monetary transmission mechanism, and monetary policy. In macroeconomics, the monetary transmission mechanism is the process that allows for a change in either demand for money or the money supply which leads to a shift in the aggregate demand curve. This process has many steps but relies on three large ideas that create the large- scale production. The first stage of the monetary transmission mechanism is the change in supply and demand of money, which allows for a change in the equilibrium interest rate in the short run. The positive change in the money supply has many different outcomes of the economy in the short run. This increase in money supply from a monetary equilibrium due to either the increase in reserves by the central bank or the increase in the commercial bank lending out their existing reserves. This change causes an excess in the money supply since more money is in circulation.
