Payment Outage, Tighter Rules
The question
A prolonged failure of the national card and mobile-payment network in the country of Norwick forces households and firms to complete the same purchases with currency and checking balances they keep on hand. During the same period, a banking law passed three years earlier phases in, raising the fraction of deposits that commercial banks must hold as reserves. Assume the price level and real income are unchanged. Show the combined effect of these two events on the money market. Show the effect on the Money Market graph.
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Payment Outage, Tighter Rules: the worked answer
On the Money Market graph, Money demand (MD) shifts right and Money supply (MS) shifts left.
Why Money demand (MD) shifts right and Money supply (MS) shifts left
Two curves move for two separate reasons. With cards and payment apps unavailable, the same volume of purchases now requires larger holdings of currency and checking deposits at every interest rate, which is an increase in money demand and shifts MD right. The scheduled increase in the required reserve ratio shrinks the money multiplier, so banks create fewer deposits on the same reserve base and the vertical MS line shifts left. Both shifts push the equilibrium nominal interest rate up, so the rate definitely rises. Now the money market parts company with a normal supply and demand diagram: because MS is perfectly inelastic and drawn vertical, the equilibrium quantity of money is read straight off MS, so it definitely falls rather than being indeterminate. This is the one combined-shift pattern on this graph where both outcomes have a determinate direction, and only the SIZE of the interest rate increase is left open, since that depends on the relative magnitudes of the two shifts.
What happens to the equilibrium
The equilibrium nominal interest rate definitely rises because both shifts push it up, and the quantity of money definitely falls because the vertical MS line alone fixes it, leaving only the magnitude of the rate increase indeterminate.
The mistake students make on this one
The specific error here is importing the supply and demand habit and writing "opposite shifts, so the quantity of money is indeterminate." That reasoning needs an upward-sloping supply curve, and the money supply in the liquidity preference model is vertical, so the quantity is whatever the banking system and the central bank produce and it falls with no ambiguity. The mirror-image error is to move only MS because the reserve requirement is the familiar policy lever and to treat the payment outage as stage dressing rather than as a money demand determinant.
On exam day
Before calling any money-market outcome indeterminate, check the shape of MS: it is vertical, so the quantity of money is never ambiguous, and the only outcome a combined shift can leave open is the interest rate, and then only when the two curves move in the same direction.
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 left 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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