Money, Interest Rates, And Exchange Rates
4 important questions on Money, Interest Rates, And Exchange Rates
Monetary developments influence the exchange rate
- changing interest rates
- changing peoples expectations about future exchange rates.
Three main factor determine aggregate money demand:
- The interest rate. If interest rate rises, aggregate money demand falls.
- The price level. If price levels rise, the aggregate money demand rises.
- Real national income. When real national income (GNP) rises, more goods will be sold so demand for money increases.
The aggregate money demand function:
Md/P=L(R,Y) where L(R,Y) is aggregat real money demand.
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A change in Ms will lead to future increases in the price level, because
- Excess demand for output and labor. ( the demand for goods will increase and wages will increase)
- Inflationary expectations. (if everyone expects the price level to rise in the future, their expectation will increase the pace of inflation today)
- Raw materials prices. (mostly sold in markets where prices adjust sharply even in the short run, this will lead to higher prices)
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