Interest Rate Determination

Key Takeaways

• Inflation arises whenever there is too much money chasing too few goods.
• A money supply increase will lead to increases in aggregate demand for goods and services.
• A money supply increase will tend to raise the price level in the long run.
• A money supply increase may also increase national output.
• A money supply increase will raise the price level more and national output less the lower the unemployment rate of labor and capital is.
• A money supply increase will raise national output more and the price level less the higher the unemployment rate of labor and capital is.
• The natural rate of unemployment is the rate that accounts for frictional unemployment. It is also defined as the rate at which there are no aggregate inflationary pressures.
• If a money supply increase drives an economy below the natural rate of unemployment, price level increases will tend to be large while output increases will tend to be small.
• If a money supply increase occurs while an economy is above the natural rate of unemployment, price level increases will tend to be small while output increases will tend to be large.