Independence and Interdependence of Fiscal & Monetary Policy
It appears to me that the AP is interested as an explanation for the direction of the RIR using the Price Level as an explanation.
Let me take a shot at explaining. (This is not for the AP explanation)
(If the Money Supply is increasing then the amount of money in circulation is increasing which with our understanding of supply and demand means that the value of the money decreases. (more money less value) The RIR is about purchasing power so if the quantity (supply) of money increases then the purchasing power of each dollar falls. As the more money supplied gets into people's hands they spend it,, more people spending money pushes the price level up, price levels increase.
Next connection & clarification.
If the money supply is increasing then the value of the currency is falling as more people have more of it and therefore demand for it falls reducing the value. RIR is a direct reflection of the cost to purchase money (borrow, get a loan). So if the supply is increasing the banks want to make loans so they lower the cost to purchase money, RIR decreases.
Next connection & clarification.
If the banks have more loanable funds then their opportunity cost of holding more cash increases and they therefore lower their interest rates (price to borrow) to entice more people to borrow. Remember that the demand curve is downward sloping on the purchasing of money (borrowing),, and to get more people to borrow the banks must lower their rates.
To explain for the AP, monetary policy expansion and the RIR, I think it is best to say that since the Price Level (PL) is increasing therefore the RIR must be falling.
 |
| Still easier than this stuff. |