Graph walkthrough · Macro · Money market

Holiday spending raises money demand

In December, households make far more purchases than usual.

Step 1 of 3 · Before the holidays

The horizontal axis is the quantity of money. The vertical axis is the nominal interest rate. Money demand slopes down and the central bank holds money supply fixed. The market is at E₀.

The chain in words

Step 1
Before the holidays
The horizontal axis is the quantity of money. The vertical axis is the nominal interest rate. Money demand slopes down and the central bank holds money supply fixed. The market is at E₀.
Step 2
Money demand shifts right
More purchases mean people want more cash and checking balances on hand at every interest rate. Money demand shifts right. At the old rate, people want to hold more money than the fixed supply.
Step 3
The interest rate rises
People sell bonds to raise cash. Bond prices fall and the interest rate rises until the fixed money stock is all anyone wants to hold, at E₁. The quantity of money did not change, only its price did.

Takeaway. With a fixed money supply, a rise in money demand raises the interest rate.

Draw it yourself

This shock: draw the graph The Fed buys bonds The Fed sells bonds The price level rises

More on the money market graph

The Fed buys bonds The Fed sells bonds Higher prices, more money demanded A lower reserve requirement

Go deeper

Lesson: The Money Market

The walkthrough shows the chain. The lesson explains why each link holds, with worked examples and practice questions that remember what you get wrong.

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