In Chapter 9, we explained the process by which an increase in the money supply could cause an increase in real GDP (denoted by ‘Q’ on an output market graph). This would typically be done to fight recession. The logic worked as follows. The increase in the money supply causes a short-run decrease in interest rates. The drop in interest rates causes more Investment spending (because it is now cheaper to pay back a given sized loan). The increase in Investment causes Aggregate Demand to shift to the right. Then we get an increase in real GDP. In symbols, the ‘chain’ of cause and effect would be:
?MS ? ?R ? ?I ? ?AggD ? ?Qe (? rGDP).
