Draw a graph of money demand and money supply

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Why might targeting the money supply lead to lower output growth than targeting the rate of interest? Consider your responses to Problems 1 and 2 before you answer.

Problems 1
Draw a graph of money demand and money supply with the nominal interest rate on the vertical axis and money balances on the horizontal axis. Assume the central bank is following a money growth rule where it sets the growth rate of money supply to zero. Use the graph to illustrate how fluctuations in velocity imply that targeting money growth results in greater volatility of interest rates.

Problems 2
Using the same graph as that described in Problem 1, show how the central bank could use its control over the quantity of money to target a particular level of interest rate in the face of changes in velocity.

Reference no: EM131223214

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