1. Monetary Policy and the Interest Rate Controlling the Supply of Money

2. Increasing the Money Supply: Effect on the Interest Rate Interest rate, r Quantity of money An increase in the money supply… r1r1 r2r2 E1E1 MS 1 MS 2 MD E2E2 …leads to a fall in the interest rate.

3. Monetary Policy and Aggregate Demand Contractionary monetary policy causes the aggregate demand curve to shift to the left (from AD 1 to AD 3 ). Expansionary monetary policy causes the aggregate demand curve to shift to the right (from AD 1 to AD 2 ). AD 2 AD 3 AD 1 Aggregate Price Level Real GDP