Money supply effect

The monetary effect is the main reason why the macroeconomic (aggregated) demand curve has a negative slope.

The effect is based on the assumption of the Keynes interest rate effect, which is expressed in three steps:

The rise in the price level leads to a monetary lump in the case of a fixed amount of money. The level of total real output is falling.

Under the assumption of unchanged technology and unchanged fiscal instruments, the following applies: real money = cash flow (constant) / price level

In economic practice, an increase in the price level causes a drop in the real money supply, which leads to higher interest rates. These allow savings to become more attractive and thus reduce spending on investment and consumption. The gross domestic product falls - equivalent to the output drop. An economic policy measure which would counteract this development would be the expansion of the money supply. It would lead to a higher inflation rate, but it would also drop interest rates, which would improve the credit conditions. Investing and consuming would therefore be more attractive than saving. The output of the national economy would rise.

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