On January the 22nd at 1.20 P.M the United States Federal reserve slashed the US interest rates by 75 basis points. The fact that they were going to lower the interest rates was not unexpected, the unexpended was the amount that they lowered it by. Usually they to 25 basis changes and as they do a changes this big its clearly tells us that the country is “sick”. This rate cut is a form of healing tool to get the US economic on its feet’s again. We have seen the house market crises as well as the devaluation of US products.
Lowering the interest rates is a simple monetary policy which leads to an increase in investments and increase in money demand. As we can see on the Money demand graph for the monetary policies we clearle can see that the effect on lowering the rate of interest leads to a move in M ss to the right (M ss 1) which increases the quantity of money. This is the beginning of the Transmission Mechanism. As you increase the money supply the money balance gets increase, this is crucial because this drives up the Aggregate Demand. And when AD is increase, the Price levels increase due to the fact that people have afford to pay more for the some product. But as the price level increases the rate of interest can increase leading to less investments and a decrease in National Income which is proportional to employment.
As we can see in the graph to the left a rise in Money SS (Mss) from Mss to Mss1 leads to the fall of the rate of interest.
This can be connected to the DD graph for Investments, to the right of the Money SS graph. As we can see it moves from I to I1 which should show an increase in investments.
As the investments increase, the Price level rise. This is showed in the graph below the Money SS and Investments. Here the infla ...