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Home/Business & Economics/Assuming that the money market is initially in equilibrium, trace through the effects of a contraction in the money supply on the money market, on the interest rate and also on output, employment and the price level. Under what circumstances would the central bank undertake this type of policy?

Assuming that the money market is initially in equilibrium, trace through the effects of a contraction in the money supply on the money market, on the interest rate and also on output, employment and the price level. Under what circumstances would the central bank undertake this type of policy?

The effects of a contraction in the money supply on the money market, on the interest rate and on output, employment, and the price level is shown in the figure below.

Sm in the figure above is the money supply level as determined by the central bank. Dm, on the other hand, is the demand for money, which represents the liquidity preference. Contractionary monetary policy is due to an increase in the rate of interest, and this leads to the leftward shift in the money supply curve. The money market responds to the contractionary monetary policy by reducing the liquidity preference from M0 to M1. The interest rate, on the other hand, increases from ie to i. From the figure above, it is clear that the contraction in the money supply leads to reduced inflation hence an increase in the price levels, reduced rate of unemployment, which will lead to an increase in the output level. The central bank would undertake the contractionary policy when the economy is faced with the risk of inflation.

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Academic.Tips. (2021) 'Assuming that the money market is initially in equilibrium, trace through the effects of a contraction in the money supply on the money market, on the interest rate and also on output, employment and the price level. Under what circumstances would the central bank undertake this type of policy'. 22 July.

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Academic.Tips. (2021, July 22). Assuming that the money market is initially in equilibrium, trace through the effects of a contraction in the money supply on the money market, on the interest rate and also on output, employment and the price level. Under what circumstances would the central bank undertake this type of policy? https://academic.tips/question/assuming-that-the-money-market-is-initially-in-equilibrium-trace-through-the-effects-of-a-contraction-in-the-money-supply-on-the-money-market-on-the-interest-rate-and-also-on-output-employment-and/

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Academic.Tips. 2021. "Assuming that the money market is initially in equilibrium, trace through the effects of a contraction in the money supply on the money market, on the interest rate and also on output, employment and the price level. Under what circumstances would the central bank undertake this type of policy?" July 22, 2021. https://academic.tips/question/assuming-that-the-money-market-is-initially-in-equilibrium-trace-through-the-effects-of-a-contraction-in-the-money-supply-on-the-money-market-on-the-interest-rate-and-also-on-output-employment-and/.

1. Academic.Tips. "Assuming that the money market is initially in equilibrium, trace through the effects of a contraction in the money supply on the money market, on the interest rate and also on output, employment and the price level. Under what circumstances would the central bank undertake this type of policy?" July 22, 2021. https://academic.tips/question/assuming-that-the-money-market-is-initially-in-equilibrium-trace-through-the-effects-of-a-contraction-in-the-money-supply-on-the-money-market-on-the-interest-rate-and-also-on-output-employment-and/.


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Academic.Tips. "Assuming that the money market is initially in equilibrium, trace through the effects of a contraction in the money supply on the money market, on the interest rate and also on output, employment and the price level. Under what circumstances would the central bank undertake this type of policy?" July 22, 2021. https://academic.tips/question/assuming-that-the-money-market-is-initially-in-equilibrium-trace-through-the-effects-of-a-contraction-in-the-money-supply-on-the-money-market-on-the-interest-rate-and-also-on-output-employment-and/.

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"Assuming that the money market is initially in equilibrium, trace through the effects of a contraction in the money supply on the money market, on the interest rate and also on output, employment and the price level. Under what circumstances would the central bank undertake this type of policy?" Academic.Tips, 22 July 2021, academic.tips/question/assuming-that-the-money-market-is-initially-in-equilibrium-trace-through-the-effects-of-a-contraction-in-the-money-supply-on-the-money-market-on-the-interest-rate-and-also-on-output-employment-and/.

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