Suppose that the central bank carries a brief expansionary monetary policy and at the same time...
Suppose that the central bank carries a brief expansionary monetary policy and at the same time there is a surge in economic activity. As a result of these two facts, it is observed that short-term interest rates increase and that, in equilibrium, agents choose to hold more monetary assets.
a) Does this information contradict the expected negative relationship between interest rates and money demand? Explain.
b) Explain what happens (and why) in terms of supply and demand for funds in the bonds market. How does this relate to the outcome observed in short-term interest rates?
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