Money Market Equilibrium

The money market model combines the supply and demand of money. At first, for the sake of simplicity, we can assume that the supply of money is controlled by the Central (National) Bank and fixed at the level of . The price level will also be assumed to be stable, which is quite acceptable for the short-term model. Then, the real supply of money will be fixed at the level and at the figure. 6.2. represented by a vertical straight LS. Demand for money (LD curve) is seen as a decreasing function of the interest rate for a given level of income (at constant price levels, nominal and real interest rates are equal). At the equilibrium point, the demand for money is equal to its supply.

A fixed interest rate keeps the money market in balance. Adjustment of the situation in order to achieve equilibrium is possible because economic agents change the structure of their assets depending on the movement of the interest rate. So, if R is too high, then the supply of money exceeds the demand for it. Economic agents who have accumulated cash will try to get rid of it by turning into other types of financial assets: stocks, bonds, term deposits, etc. A high interest rate, as already mentioned, corresponds to a low bond rate, so it will be profitable to buy cheap bonds based on income from the appreciation of their rate in the future, due to a decrease in R. Banks and other financial institutions in conditions of excess supply of money over demand will begin to reduce interest rates. Rates. Gradually, through the change in the structure of their assets by economic agents and the reduction of their interest rates by banks, the equilibrium in the market will be restored. With a low interest rate, the processes will go in the opposite direction.

Fluctuations in the equilibrium values of the interest rate and the money supply can be associated with changes in exogenous variables of the money market: the level of income, the supply of money. Graphically, this is reflected by the shift, respectively, of the supply and demand curves of money.

Thus, a change in the level of income, for example, its increase (see Fig. 6.3.), increases the demand for money (shifting to the right the demand curve for money LD) and the interest rate (from R1 to R2). The reduction in the money supply also leads to an increase in the interest rate (Fig. 6.4.).

Such a mechanism for establishing and maintaining equilibrium in the money market can work successfully in an established market economy with a developed market of valuable magicians, with established behavioral connections – a typical action of economic agents to change certain variables, say, the interest rate.