We mentioned how difficult it can be for the Federal Reserve to actually control aggregate demand: Its control over the broader money supply (M1 and M2) is weak and indirect, plus it can’t control velocity very much at all. Let’s translate the following bullet points from the chapter into an expanded aggregate demand equation. You know that increasing AD means increasing spending growth, but now you know that M (growth in M1 or M2, money measures that include checking accounts) depends on growth in the monetary base (MB) and on the money multiplier (MM). That means an increase in AD requires an increase in
Let’s apply this fact to the following cases mentioned in the chapter. In all cases, the Federal Reserve is trying to boost AD by raising But if there’s a fall in or a fall in at the same time, the Fed’s actions might do nothing to AD.
In each case below, what are we concerned about: a fall in or a fall in ?
a. Will banks lend out all the new reserves or will they lend out only a portion, holding the rest as excess reserves?
b. Will increases in the monetary base translate into new bank loans?
c. If businesses do borrow, will they promptly hire labor and capital, or will they just hold the money as a precaution against bad times?