Description                                  
In this presentation, the narrator explains how the equilibrium interest rate is determined and maintained through monetary policy.  

Narrator: 
The money market, represented by the supply and demand curves for money, determines the equilibrium interest rate in the marketplace. 

Narrator: 
The money supply curve is a vertical line on this graph because we assume that the Federal Reserve manipulates the money supply independent of the interest rate using the monetary policy tools discussed in the preceding presentation. 

Narrator: 
The equilibrium interest rate occurs at the intersection of the vertical money supply curve as determined by the Fed and the downward sloping money demand curve, which is determined by households and firms. 

Narrator: 
Any tendency for the interest rate to move from the equilibrium level will be met by market forces, which move it back to its equilibrium level. 

Narrator: 
If the rate of interest rises above the equilibrium level, money supply exceeds money demand causing interest rates to decline. Conversely, an interest rate below the equilibrium level produces an excess demand for money causing interest rates to rise. 

Narrator: 
The Federal Reserve manipulates the market interest rate by changing the supply of money. Expansionary monetary policy entails increasing the supply of money, which lowers the interest rate and leads to economic expansion. Conversely, contractionary monetary policy entails reducing the supply of money causing interest rates to rise and economic activity to be reduced. 

Narrator: 
Changes in money demand also effect the interest rate. An increase in the demand for money tends to increase the rate of interest, while a reduction in the demand for money tends to reduce the rate of interest. 

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