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The money market equilibrium diagram. The LM curve shows the combinations of interest rates and levels of real income for which the money market is in equilibrium. It shows where money demand equals money supply. For the LM curve, the independent variable is income and the dependent variable is the interest rate.
The 45-degree line represents an aggregate supply curve which embodies the idea that, as long as the economy is operating at less than full employment, anything demanded will be supplied. Aggregate expenditure and aggregate income are measured by dividing the money value of all goods produced in the economy in a given year by a price index.
The graph depicts an increase (that is, right-shift) in demand from D 1 to D 2 along with the consequent increase in price and quantity required to reach a new equilibrium point on the supply curve (S). A common and specific example is the supply-and-demand graph shown at right.
Monetary policy affects stock prices, leading to changes in Tobin's q (the market value of firms divided by the replacement cost of capital) and investment [2] Wealth effects; Monetary policy affects stock prices, which affects financial wealth and consumption (consumer spending on nondurable goods and services) [5] Uncertainty channel
The net return on bonds is the sum of the interest payments and the capital gains (or losses) from their varying market value. A rise in interest rates causes aftermarket bond prices to fall, and that implies a capital loss from holding bonds. Accordingly, the return on bonds can be negative. Thus, people may hold money to avoid the loss from ...
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Hence, the equilibrium (or market) interest rate is not only influenced by the propensities to save and invest but also by the creation or destruction of fiat money and credit. If the bank system enhances credit, it will at least temporarily diminish the market interest rate below the natural rate. Wicksell had defined the natural rate as that ...
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