Question

Explain the links between changes in the nation's money supply, the interest rate, investment spending, aggregate demand, real GDP, and the price level.

Short answer

The nation's money supply, interest rates, investment spending, aggregate demand, real GDP, and price levels are interlinked in a way that the increase or decrease in one of these will cause an increase or decrease in the other.

Step-by-step solution

Step 1. Relation between money supply, interest rate, investment spending, aggregate demand, real GDP, and price level

Their linkage can be explained through an example. Suppose there is an increase in the economy's money supply due to some exogenous factors. With the increase in money supply, investment spending will increase as people will have more purchasing power.

The aggregate demand will increase with increased spending asthe investment will cause more employment and eventually more income.This will lead to an increased GDP. However, if the demand goes on to increase, it will increase the money supply. The price levels will increase, causing inflationary tendencies, and the Fed will increase the interest rates to snatch the purchasing power from the hands of the people and bring inflationary tendencies down.