Controlled by the Central Bank

• Central banks change the money supply by messing with bank reserves.
• For simplicity's sake, let's say the central bank solely determines the money supply.

 How Interest Rates Are Determined by the Central Bank 🎯

• The central bank sets the money supply to achieve an equilibrium interest rate.
• Too much demand for money? Interest rates go up!
• Too much supply? Interest rates go down!

 What Is the Demand for Money?

• Think of demand for money like wanting to keep a giant pile of cash in your basement instead of investing it.
• If you had $100 million, you could keep it as cash (earning no interest) or buy a government bond (earning interest).

 Why Demand Money? 🤔

• Transactions motive: You need money to buy stuff like groceries (can't pay with government bonds!).
• More money is needed for transactions if the country's income (nominal income) or average price level goes up.

The Trade-Off Between Convenience and Earnings

• Keeping money in a demand deposit is super convenient but earns no interest.
• Sammy, for example, might miss out on interest by keeping his funds in a demand deposit instead of a bond.

 How Interest Rates Affect Money Demand 📉

• Higher interest rates = less demand for money (because you'd rather earn interest!)
• Demand for money is negatively sloped against interest rates.
• If nominal income (money GDP) increases, demand for money shifts to the right