Money Market

Draw a graph of the money market and the impact high inflation will have on the nominal interest rate.

What is the money market used for?

• To determine inflation.

• To create less scarcity.

• To illustrate changes in the nominal interest rate.

• To illustrate how fiscal policy changes spending.

Role of money market in India:

• Growth of Commerce, Trade and Industry

• Shortage of funds

• Seasonal fluctuations

• Delay in technological upgradation

Which of the following will shift the money demand curve from M^d1 to M^d2?

• A fall in the interest rate

• An advance in payment technology

• A change from a weekly payroll to a monthly payroll

• A decrease in the risk of holding other assets

Answer explanation

A rise in the time interval between successive income receipts will increase money demand.

A is incorrect. A fall in the interest rate will result in a downward movement along the same money demand curve.

B and D are incorrect. Money demand decreases and the money demand curve will shift to the left.

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6.2 Interest-rate determination

Refer to the diagram above. Which of the following statements are correct?

• (1) and (2) only

• (1) and (3) only

• (2) and (3) only

• (1), (2) and (3)

Answer explanation

(2) is incorrect. The interest rate will rise because of the shortage of money in the money market.

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6.2 Interest-rate determination

Which of the following will increase the money supply?

• and (2) only

• and (3) only

• and (3) only

•  (1), (2) and (3)

Answer explanation

(1) is correct. This increases the banking multiplier and then the money supply.

(3) is incorrect. Money supply decreases because less money will be created by banks’ credits.

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6.3 Monetary policy

Which of the following will shift the money supply curve from M^s₁ to M^s₂?

• A fall in the discount rate

• A fall in the required reserve ratio

• An open market purchase

• None of the above

Answer explanation

The money supply curve shifts leftward, i.e., there is a reduction in the money supply.

The events in A, B and C will increase the money supply and the money supply curve will shift to the right.

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6.3 Monetary policy

Which of the following may help combat inflation?

• (1) and (2) only

• (1) and (3) only

• (2) and (3) only

•  (1), (2) and (3)

Answer explanation

All of them reduce the money supply. This helps lower the demand for goods and the general price level.

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6.3 Monetary policy

The interest rate may increase when there is

• a fall in money demand.

• a rise in money supply.

• a fall in money demand accompanied by a fall in money supply.

• a fall in money demand accompanied by a rise in money supply.

Answer explanation

A fall in the money demand decreases the interest rate, but a fall in the money supply increases the interest rate.

If the money supply falls by a larger amount than the money demand, the interest rate will increase.

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6.2 Interest-rate determination

The money market is the market in which ............

• A new issues of securities

• Previously issued securities

• Short-term debt instruments

• Long-term debt and equity instruments