Boom Meets Bond Buying
The question
In the country of Ferren, nominal gross domestic product climbs sharply as both real output and the aggregate price level rise, so households and firms carry out more and larger transactions each month. In that same quarter, following a purchase schedule its board approved a year earlier, the central bank of Ferren buys a large quantity of government bonds from commercial banks. Show the combined effect of these two events on the money market. Show the effect on the Money Market graph.
Drag a curve, or use the arrow buttons. Want the free-play version with every control? Open this graph in the sandbox.
Boom Meets Bond Buying: the worked answer
On the Money Market graph, Money demand (MD) shifts right and Money supply (MS) shifts right.
Why Money demand (MD) shifts right and Money supply (MS) shifts right
Two independent shifters are at work, so two curves move. Money is held mainly to make transactions, and a higher nominal GDP means more and larger transactions at every interest rate, so desired money holdings rise and MD shifts right. Separately, the central bank pays for the bonds it buys with newly created reserves, banks lend those reserves out, deposits expand, and the vertical MS line shifts right. The quantity of money is determinate: MS is vertical, the central bank has moved it right, so the equilibrium quantity rises. The equilibrium nominal interest rate is INDETERMINATE. The rightward MD shift pushes the rate up and the rightward MS shift pushes it down, and which force wins depends on the relative size of the two shifts. If money demand grows by more than the money supply the rate rises, if the money supply grows by more the rate falls, and if the two are equal the rate is unchanged.
What happens to the equilibrium
The quantity of money definitely rises because the central bank's purchase moves the vertical MS line right, while the equilibrium nominal interest rate is indeterminate and depends on which of the two shifts is larger.
The mistake students make on this one
The dominant wrong answer commits to a direction for the interest rate, almost always by writing "more money in the economy, so the interest rate falls" after reading only the open-market purchase and treating the nominal GDP sentence as background color. The rise in nominal GDP is a genuine money demand determinant that pushes the rate the other way, so the direction of the rate cannot be settled without knowing which shift is bigger. The quantity of money is the one outcome you may state outright, so a student who sounds certain about both is being certain about the wrong one.
On exam day
When a money-market stem contains two separate shocks, draw both arrows before you read any outcome, and write the sentence "the change in the nominal interest rate is indeterminate, since it depends on the relative magnitudes of the shifts" rather than guessing a direction, because readers award the point for naming the indeterminacy.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when Money demand (MD) shifts right and Money supply (MS) shifts right and every other curve on the Money Market graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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