The following diagram shows the demand for and supply of money. The equilibrium quantity of money is initially
Q1 and the equilibrium interest rate is
r1.
Assuming that a central bank wishes to tighten monetary policy in order to reduce inflation, which of the following would NOT be appropriate?
◦ Keep interest rates at
r1 and keep the money supply curve at
Ms but ration credit.
◦ Keep interest rates at
r1 and reduce the money supply to
Q2 and also ration credit.
◦ Reduce the money supply (e.g. from
Q1 to
Q2) by taking action to shift the money supply curve to the left. In so doing, it must allow interest rates to rise if it is to avoid credit rationing.
◦ Raise the interest rate to
r2 and then reduce the money supply to Q
2 and not introduce any form of credit rationing.
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A cartoon of “King Andrew the First” shows Jackson standing atop the U.S. Constitution—a scepter in