<p>There are a few sub-questions in this question, and I will not attempt to answer all of them. These “economics 101” models are extremely abstract, and it takes a lot of effort to relate them to observed economic behaviour. (I worked in fixed income research for 15 years, and cannot recall industry research ever referring to them.)</p>

<p>“Households” stand in for the entire private sector. (In these models, firms’ financial asset holdings are normally assumed to be zero, as otherwise, they would also have to solve a multi-period optimisation to maximise profits. This breaks the models, as there are then two sectors with competing multi-period optimisations.) </p>

<p>Financial assets are issued by the government sector (Treasury/central bank), although the models may allow reverse borrowing by households by allowing them to have negative bond holdings (which little literal sense in the real world).</p>

<p>Since you asked about it in comments, I will add some details to the institutional structure. In these models, like in the real world, the Treasury is the financial arm of the government. (In some countries, labelled the Ministry of Finance.) It owns the central bank, and leaves its cash on deposit at the central bank. Since this deposit is a liability between two related entities, it does not show up in the money supply numbers. If we consolidate the accounting, the deposit is money the entire government owes to itself, and so it disappears from the balance sheet. And to repeat: this is not just a model simplification, it is how real world statistical agencies do the accounting for the money supply. Note that governmental liabilities are only the narrowest components of the money supply (“M0”), wider aggregates (“M3”) include private sector instruments - which do not appear in this class of models. </p>

<p>The household money demand equation is just a portfolio allocation decision: given a portfolio size, what is the breakdown between money and bonds? The greater the interest rate, the greater the percentage held in bonds.</p>

<p>The central bank is the counterparty to the household sector portfolio decision. When it buys bonds, money returns to the central bank. Since money is a liability of the central bank, it does not hold it as an asset, so the money is “destroyed” - the stock of money contracts.</p>

<p>The money cannot go to the Treasury or firms, since the model construction does not allow for it.</p>

<p>This site wants to keep opinions out of answers. However, it is clear that there are a lot of issues with how (neo-)classical models handle “money”, as most “money” (broad money supply aggregates) are private sector liabilities (e.g., bank deposits). There is a large post-Keynesian literature on money and finance, the key words to look for is “endogenous money”. These critiques of the classical models might help you relate them to real world behaviour, as the post-Keynesians like to explain the deficiencies of the classical models. I cannot think of any immediate reference, but you could search. In anymevent, it would be easier to find an existing critique than attempt to re-invent your own monetary theory.</p>

CC BY-SA 3.0
2018-04-19T15:28:53.920Z
Hi Brian, thanks for the insight but I still can not explicate this process，or I have a different understanding of this process. 

I am aware that the central bank can issue bonds , thus effectively reduce the **real money supply**, and I also have no issue with the assumption that firms have 0 financial holding.  If the central bank is the only entity who can issue bonds, I would not have a quarrel with the model.
Luminia Qs
CC BY-SA 3.0
2018-04-19T15:29:02.027Z
since in this case, central bank can "sell" bonds or "buy" money at the "price" of a higher interest rate. In this case, the cause is the **central bank's willingness/involvement** to reduce **M/p, the real money supply** and the increase in intrest rate is only a **method** by which the central bank can manipulate money demand and ,indirectly, money supply. So if interest rate is raised in this way, the aggregate money supply, or **M/p**, must decrease. This reflects well in the market equilibrium forumla **M/p=Md(Y,r)**.
Luminia Qs
CC BY-SA 3.0
2018-04-19T15:29:25.143Z
However, central bank is not the only entity who can issue bonds and neither is it the only source of causes for increases in interest rate. If central banks are not involved, then the bonds are issued by firms or government and the interest rate can still effectively increase due to increase in the influx of more bonds relative to money. In this case, bonds only function as a money transfer within the private sector, matter not if the financial holdings of firms are 0; It is unequivocally true that your loss of money is someone-else's gain of money.
Luminia Qs
CC BY-SA 3.0
2018-04-19T15:29:40.087Z
So, in this case, interest rate has no correspondence,negative or positive, with the **aggregate money demand**. In fact, changes in interest rate would affect **Md(Y,r)** if and only if the central bank is the entity who elicited these changes.
Luminia Qs
CC BY-SA 3.0
2018-04-19T15:29:59.750Z
It it not impossible to come up with this example. Imagine John is a fervent money lover and he just want to keep money piled in his backyard. So he issued high interest bonds, assume he somehow miraculously allowed to do so; So the interest rate in the money market increased but the total money demand remains constant because John himself is also a constituent of the private sector.
Luminia Qs
CC BY-SA 3.0
2018-04-19T15:34:19.223Z
the way I treat money demand is to break it into two parts: **Me**, denoting the money active and Ms,the money dormant. Clearly, Me is positively related to Y, GDP, as the increase of productivity spike the amount of transaction ,and Ms is negatively related to interest rate as higher interest rate would encourage people opting to bonds, so that **the debtor would invest the money from bond sales into circulation**. In this way **M(Y,r) = Me(Y) + Ms(r)**.
Luminia Qs
CC BY-SA 3.0
2018-04-19T15:36:32.470Z
The key point is that even if **Ms** decreases because of bond sales **Me** would most like increase from these sales, as bonds only function as a money transfer in this sense, so the aggregate demand **Md(Y,r)** remains constant. Then although interest rate is inversely related to **Ms**, it does not imply **Md(Y,r)** is inversely related to interest rate as well, unless we define **Md** as **Ms**.
Luminia Qs
CC BY-SA 3.0
2018-04-19T15:37:33.843Z
If we do not complicate the issue and just analyze the impact of **Y,GDP,** on interest rate, It is clear that if money supply is kept at constant, an increase in **Y** will result an up in **Me** and thus less **Ms** for bond trading; This effectively increase the value of money and thus increase the interest rate. This is, in my opinion, the natural or reasonable way of interpreting the **LM** curve but all the literature I found invariably claim a negative relationship between **Md** and **r** which makes no sense to me at all.
Luminia Qs
CC BY-SA 3.0
2018-04-19T15:46:18.350Z
On a side note, I think that the currently model is just bluntly "wrong" or a more lenient choice of word "inaccurate" as you have mentioned that industrial research may never refer to these models; It does feel that the current literature is more "econocryptics" rather than economics.
Luminia Qs
CC BY-SA 3.0
2018-04-19T18:12:40.017Z
@LuminiaQs - You wrote that “Central bank is not the only entity who can issue bonds”. In this class of models, and in most countries, central banks do not issue bonds. They buy bonds that are issued by the Treasury. And in this model, the only issuer of bonds is the Treasury, and the only buyer from households is the central bank. What you are discussing would be a completely different model.
Brian Romanchuk
CC BY-SA 3.0
2018-04-19T19:49:40.680Z
Hi Brian, thanks for the reply. I am not familiar with the institutional compartments of an economy. But the answer actually brings more questions if you could indulge me. What is the function of a treasury? From your description, it seems that treasury functions as a "sink", i.e. all the money gained by treasury through bonds become dormant thus effectively reduce the total money supplied. If that is the case, isn't treasure basically the same as a central bank, an entity with two different names?
Luminia Qs
CC BY-SA 3.0
2018-04-19T19:49:50.700Z
Since central bank is the body who controls money supply, and if a treasury also controls money supply through issuing bonds, aren’t they basically the same? If they are not the same and the central bank is the only entity who can determine **M/p**, then, in order to satisfy money supply/demand equilibrium, the amount of money hold by the treasury must be added in the calculation of aggregate demand, since money doesn’t just disappear.
Luminia Qs
CC BY-SA 3.0
2018-04-19T19:50:20.377Z
The key idea is that, no matter how we look at the problem. There are two different concepts of money supply. The first is about the total money supplied by the central bank and the second is about the “active” money the economy depends on to operate. This two concepts of money supply are not interchangeable and this is the reason why I have problem with this model.
Luminia Qs
CC BY-SA 3.0
2018-04-19T19:50:34.693Z
So, we have to be clear what we mean by holding **M/p** constant, which is an assumption I see quite often; If we say the amount of money from central bank is constant, there could well be a case when the treasury sell bonds and reduce the “active” money in the market thus increase interest rate; on the other hand, if we say the “active” money is hold constant, there could well be a case when the central bank buys bonds from treasury thus increase the total money supplied by central bank and decrease interest rate.
Luminia Qs
CC BY-SA 3.0
2018-04-19T19:50:58.693Z
So how do we define money demand? If we let money demand amounts to the total money from central bank, then in the first case, money demand remains constant with an increase in interest rate and in the second case, money demand increased with lower interest rate; if we let money demand amounts to the “active” money, then in the first case money demand decreased with higher interest rate and in the second case it remains constant with lower interest rate. In both case, Y, or income, is hold constant.
Luminia Qs
CC BY-SA 3.0
2018-04-19T19:52:57.033Z
So we are faced with a dilemma, if we want to conclude that money demand is negatively related to interest rate, we must have money demand defined as “active” money in the first case and defined as total money in the second case.The only way to resolve this dilemma, or it seems to me, is to assume treasury and central bank function as a unity and be the only entity who can issue bonds. I would agree with this construction.
Luminia Qs
CC BY-SA 3.0
2018-04-19T19:53:07.327Z
However, even if I accept this construction, I have seen analysis of problems that confuse the two concepts and apply a result from one definition to analyze problems with a different set of definition.
Luminia Qs
CC BY-SA 3.0
2018-04-20T12:40:11.077Z
@LuminiaQs The preference on this site is to not have conversations in the comments. Moderators might delete this entire conversation. I will add a couple points to my answer. There is a chat feature; I don’t know how to start one, but I could discuss this there.
Brian Romanchuk
CC BY-SA 3.0
2018-04-20T18:58:13.617Z
Hi Brian, thanks for the answers. I think you have explained the model well and its hidden presumptions; the presumptions are really what I was looking for. I don't really mind, at this moment,  if a theory is true realistically but It does bother me if the theory is not ,at least,  "consistent".  I would probably form my own eclectic idea from  sources like post-Keynesian theories later in my study; for now I will just swallow the model.
Luminia Qs
CC BY-SA 3.0
2018-04-19T12:16:40.673Z
2018-04-20T12:52:36.360Z
2018-04-20T12:52:36.360Z
Brian Romanchuk
<p>One thing to consider is that, when the Federal Reserve in the United States tries to manipulate the money supply, it does so through either putting more of its money into the market through bond purchases (supplying banks with money to lend) or holding money from the market through bond sales (leaving the money essentially dormant). It is not so much that bond creators receive money when people turn to bonds with higher interest rates but rather that the bonds change hands to people (households, firms, banks) who would have actually circulated money in some way if they held it in liquid form. The missing link is the central bank's money holdings.</p>

CC BY-SA 3.0
2018-04-19T04:44:22.997Z
Hi thanks for the insight. I am aware that the central bank can manipulate the money market; in fact it is them who supply the real money, **M/P**, to the market. However, it would still not explain why the money demand, **Md(Y,r)**, is inversely related to **r**, which is the interest rate. As far as I can tell, the interest rate will only reduced the money lay dormant in the hands of either households or firms.
Luminia Qs
CC BY-SA 3.0
2018-04-19T04:58:36.943Z
in other words, the total money demand has two aspects: **Me**, denoting the money in circulation and **Ms**,the money in dormant. Clearly, **Me** is positively related to Y, GDP, as the increase of productivity spike the amount of transaction ,and **Ms** is negatively related to interest rate as higher interest rate would encourage people opting to bonds, so that **the debtor would invest the money from bond sales into circulation**.
Luminia Qs
CC BY-SA 3.0
2018-04-19T05:02:38.403Z
The key point is that even if **Ms** decreases because of bond sales **Me** would most like increase from these sales, as bonds only function as a money transfer in this sense, so the aggregate demand **Md(Y,r)** remains constant. Then although interest rate is inversely related to **Ms**, it does not imply **Md(Y,r)** is inversely related to interest rate as well, unless we define **Md** as **Ms**.
Luminia Qs
CC BY-SA 3.0
2018-04-19T05:14:55.757Z
If we do not complicate the issue and just analyze the impact of **Y**,GDP, on interest rate, It is clear that if money supply is kept at constant, an increase in Y will result an up in **Me** and thus less **Ms** for bond trading; This effectively increase the value of money and thus increase the interest rate. This is, in my opinion, the natural or reasonable way of interpreting the LM curve but all the literature I found invariably claim a negative relationship between **Md** and **r** which makes no sense to me at all.
Luminia Qs
CC BY-SA 3.0
2018-04-19T02:41:36.603Z
2018-04-19T02:41:36.603Z
the_evictor
<p>In the description of so-called money market, we have demand,<strong>Md</strong>, for liquid money from individuals (and firms) and supply,<strong>Ms</strong>, of liquid money, likely from central banks. Now it is assumed that if interest rate,<strong>r</strong>, would increase, the demand for money,<strong>Md</strong>, would decrease due to people's preference of bonds(or other high yield securities) over money at high interest rate. </p>

<p>This doesn't make sense; whereas it is true that "households" would buy bonds in exchange for money at higher <strong>r</strong>, bonds are simply transfers of money, from households to firms or governments. So the aggregate money in the economy remains constant, as firms/governments would utilize the bonds' money in the economy. Thus, if we consider the economy as a whole, the "demand" for money does not change with people opting for bonds.</p>

<p>If we only consider the households' demand for money, then the analysis in money theory and LM curve would be inaccurate; In the discussion of LM curve, we have <strong>MV=PY</strong> and <strong>M/P =Md(Y,r)</strong>. <strong>M/P</strong> essentially denote the "real money" supply from central bank. In the first formula <strong>MV=PY</strong> derived from money theory, If <strong>M/P</strong> hold constant, <strong>Y</strong>, also known as the aggregate income, is also constant; This is consistent if we consider the economy as a whole. However, in the second formula, It is understood that the money demand <strong>Md(Y,r)</strong> account for only the "households". It is unreasonable to discuss the dynamic between money supply and money demand when we have the whole economy in consideration on one hand and have only a sector of the economy weighted on another hand. </p>

<p>To sum up, I can understand that higher interest rate could encourage people to save up, thus effectively reduced the amount of money in circulation so reducing the "demand" but I do not see how opting for bonds decrease the demand for money unless only a sector of the economy is taken into consideration. Can someone provide some insight into this?</p>

<macroeconomics>
Why investing in bonds imply a decrease in money demand?
Luminia Qs
# Why investing in bonds imply a decrease in money demand?

(Asked by: username_0 on 2018-04-18)

In the description of so-called money market, we have demand,**Md**, for liquid money from individuals (and firms) and supply,**Ms**, of liquid money, likely from central banks. Now it is assumed that if interest rate,**r**, would increase, the demand for money,**Md**, would decrease due to people's preference of bonds(or other high yield securities) over money at high interest rate.

This doesn't make sense; whereas it is true that "households" would buy bonds in exchange for money at higher **r**, bonds are simply transfers of money, from households to firms or governments. So the aggregate money in the economy remains constant, as firms/governments would utilize the bonds' money in the economy. Thus, if we consider the economy as a whole, the "demand" for money does not change with people opting for bonds.

If we only consider the households' demand for money, then the analysis in money theory and LM curve would be inaccurate; In the discussion of LM curve, we have **MV=PY** and **M/P =Md(Y,r)**. **M/P** essentially denote the "real money" supply from central bank. In the first formula **MV=PY** derived from money theory, If **M/P** hold constant, **Y**, also known as the aggregate income, is also constant; This is consistent if we consider the economy as a whole. However, in the second formula, It is understood that the money demand **Md(Y,r)** account for only the "households". It is unreasonable to discuss the dynamic between money supply and money demand when we have the whole economy in consideration on one hand and have only a sector of the economy weighted on another hand.

To sum up, I can understand that higher interest rate could encourage people to save up, thus effectively reduced the amount of money in circulation so reducing the "demand" but I do not see how opting for bonds decrease the demand for money unless only a sector of the economy is taken into consideration. Can someone provide some insight into this?

**Tags:** macroeconomics

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## 2 answers

### Answer by username_1 on 2018-04-19. Score: 0 | Accepted answer

There are a few sub-questions in this question, and I will not attempt to answer all of them. These “economics 101” models are extremely abstract, and it takes a lot of effort to relate them to observed economic behaviour. (I worked in fixed income research for 15 years, and cannot recall industry research ever referring to them.)

“Households” stand in for the entire private sector. (In these models, firms’ financial asset holdings are normally assumed to be zero, as otherwise, they would also have to solve a multi-period optimisation to maximise profits. This breaks the models, as there are then two sectors with competing multi-period optimisations.)

Financial assets are issued by the government sector (Treasury/central bank), although the models may allow reverse borrowing by households by allowing them to have negative bond holdings (which little literal sense in the real world).

Since you asked about it in comments, I will add some details to the institutional structure. In these models, like in the real world, the Treasury is the financial arm of the government. (In some countries, labelled the Ministry of Finance.) It owns the central bank, and leaves its cash on deposit at the central bank. Since this deposit is a liability between two related entities, it does not show up in the money supply numbers. If we consolidate the accounting, the deposit is money the entire government owes to itself, and so it disappears from the balance sheet. And to repeat: this is not just a model simplification, it is how real world statistical agencies do the accounting for the money supply. Note that governmental liabilities are only the narrowest components of the money supply (“M0”), wider aggregates (“M3”) include private sector instruments - which do not appear in this class of models.

The household money demand equation is just a portfolio allocation decision: given a portfolio size, what is the breakdown between money and bonds? The greater the interest rate, the greater the percentage held in bonds.

The central bank is the counterparty to the household sector portfolio decision. When it buys bonds, money returns to the central bank. Since money is a liability of the central bank, it does not hold it as an asset, so the money is “destroyed” - the stock of money contracts.

The money cannot go to the Treasury or firms, since the model construction does not allow for it.

This site wants to keep opinions out of answers. However, it is clear that there are a lot of issues with how (neo-)classical models handle “money”, as most “money” (broad money supply aggregates) are private sector liabilities (e.g., bank deposits). There is a large post-Keynesian literature on money and finance, the key words to look for is “endogenous money”. These critiques of the classical models might help you relate them to real world behaviour, as the post-Keynesians like to explain the deficiencies of the classical models. I cannot think of any immediate reference, but you could search. In anymevent, it would be easier to find an existing critique than attempt to re-invent your own monetary theory.

> **Comments:**
> **username_0**: Hi Brian, thanks for the insight but I still can not explicate this process，or I have a different understanding of this process.   I am aware that the central bank can issue bonds , thus effectively reduce the **real money supply**, and I also have no issue with the assumption that firms have 0 financial holding.  If the central bank is the only entity who can issue bonds, I would not have a quarrel with the model.  
> **username_0**: since in this case, central bank can "sell" bonds or "buy" money at the "price" of a higher interest rate. In this case, the cause is the **central bank's willingness/involvement** to reduce **M/p, the real money supply** and the increase in intrest rate is only a **method** by which the central bank can manipulate money demand and ,indirectly, money supply. So if interest rate is raised in this way, the aggregate money supply, or **M/p**, must decrease. This reflects well in the market equilibrium forumla **M/p=Md(Y,r)**.  
> **username_0**: However, central bank is not the only entity who can issue bonds and neither is it the only source of causes for increases in interest rate. If central banks are not involved, then the bonds are issued by firms or government and the interest rate can still effectively increase due to increase in the influx of more bonds relative to money. In this case, bonds only function as a money transfer within the private sector, matter not if the financial holdings of firms are 0; It is unequivocally true that your loss of money is someone-else's gain of money.  
> **username_0**: So, in this case, interest rate has no correspondence,negative or positive, with the **aggregate money demand**. In fact, changes in interest rate would affect **Md(Y,r)** if and only if the central bank is the entity who elicited these changes.  
> **username_0**: It it not impossible to come up with this example. Imagine John is a fervent money lover and he just want to keep money piled in his backyard. So he issued high interest bonds, assume he somehow miraculously allowed to do so; So the interest rate in the money market increased but the total money demand remains constant because John himself is also a constituent of the private sector.  
> **username_0**: the way I treat money demand is to break it into two parts: **Me**, denoting the money active and Ms,the money dormant. Clearly, Me is positively related to Y, GDP, as the increase of productivity spike the amount of transaction ,and Ms is negatively related to interest rate as higher interest rate would encourage people opting to bonds, so that **the debtor would invest the money from bond sales into circulation**. In this way **M(Y,r) = Me(Y) + Ms(r)**.  
> **username_0**: The key point is that even if **Ms** decreases because of bond sales **Me** would most like increase from these sales, as bonds only function as a money transfer in this sense, so the aggregate demand **Md(Y,r)** remains constant. Then although interest rate is inversely related to **Ms**, it does not imply **Md(Y,r)** is inversely related to interest rate as well, unless we define **Md** as **Ms**.  
> **username_0**: If we do not complicate the issue and just analyze the impact of **Y,GDP,** on interest rate, It is clear that if money supply is kept at constant, an increase in **Y** will result an up in **Me** and thus less **Ms** for bond trading; This effectively increase the value of money and thus increase the interest rate. This is, in my opinion, the natural or reasonable way of interpreting the **LM** curve but all the literature I found invariably claim a negative relationship between **Md** and **r** which makes no sense to me at all.  
> **username_0**: On a side note, I think that the currently model is just bluntly "wrong" or a more lenient choice of word "inaccurate" as you have mentioned that industrial research may never refer to these models; It does feel that the current literature is more "econocryptics" rather than economics.  
> **username_1**: @LuminiaQs - You wrote that “Central bank is not the only entity who can issue bonds”. In this class of models, and in most countries, central banks do not issue bonds. They buy bonds that are issued by the Treasury. And in this model, the only issuer of bonds is the Treasury, and the only buyer from households is the central bank. What you are discussing would be a completely different model.  
> **username_0**: Hi Brian, thanks for the reply. I am not familiar with the institutional compartments of an economy. But the answer actually brings more questions if you could indulge me. What is the function of a treasury? From your description, it seems that treasury functions as a "sink", i.e. all the money gained by treasury through bonds become dormant thus effectively reduce the total money supplied. If that is the case, isn't treasure basically the same as a central bank, an entity with two different names?  
> **username_0**: Since central bank is the body who controls money supply, and if a treasury also controls money supply through issuing bonds, aren’t they basically the same? If they are not the same and the central bank is the only entity who can determine **M/p**, then, in order to satisfy money supply/demand equilibrium, the amount of money hold by the treasury must be added in the calculation of aggregate demand, since money doesn’t just disappear.  
> **username_0**: The key idea is that, no matter how we look at the problem. There are two different concepts of money supply. The first is about the total money supplied by the central bank and the second is about the “active” money the economy depends on to operate. This two concepts of money supply are not interchangeable and this is the reason why I have problem with this model.  
> **username_0**: So, we have to be clear what we mean by holding **M/p** constant, which is an assumption I see quite often; If we say the amount of money from central bank is constant, there could well be a case when the treasury sell bonds and reduce the “active” money in the market thus increase interest rate; on the other hand, if we say the “active” money is hold constant, there could well be a case when the central bank buys bonds from treasury thus increase the total money supplied by central bank and decrease interest rate.  
> **username_0**: So how do we define money demand? If we let money demand amounts to the total money from central bank, then in the first case, money demand remains constant with an increase in interest rate and in the second case, money demand increased with lower interest rate; if we let money demand amounts to the “active” money, then in the first case money demand decreased with higher interest rate and in the second case it remains constant with lower interest rate. In both case, Y, or income, is hold constant.  
> **username_0**: So we are faced with a dilemma, if we want to conclude that money demand is negatively related to interest rate, we must have money demand defined as “active” money in the first case and defined as total money in the second case.The only way to resolve this dilemma, or it seems to me, is to assume treasury and central bank function as a unity and be the only entity who can issue bonds. I would agree with this construction.  
> **username_0**: However, even if I accept this construction, I have seen analysis of problems that confuse the two concepts and apply a result from one definition to analyze problems with a different set of definition.  
> **username_1**: @LuminiaQs The preference on this site is to not have conversations in the comments. Moderators might delete this entire conversation. I will add a couple points to my answer. There is a chat feature; I don’t know how to start one, but I could discuss this there.  
> **username_0**: Hi Brian, thanks for the answers. I think you have explained the model well and its hidden presumptions; the presumptions are really what I was looking for. I don't really mind, at this moment,  if a theory is true realistically but It does bother me if the theory is not ,at least,  "consistent".  I would probably form my own eclectic idea from  sources like post-Keynesian theories later in my study; for now I will just swallow the model.  

---

### Answer by username_2 on 2018-04-19. Score: 0

One thing to consider is that, when the Federal Reserve in the United States tries to manipulate the money supply, it does so through either putting more of its money into the market through bond purchases (supplying banks with money to lend) or holding money from the market through bond sales (leaving the money essentially dormant). It is not so much that bond creators receive money when people turn to bonds with higher interest rates but rather that the bonds change hands to people (households, firms, banks) who would have actually circulated money in some way if they held it in liquid form. The missing link is the central bank's money holdings.

> **Comments:**
> **username_0**: Hi thanks for the insight. I am aware that the central bank can manipulate the money market; in fact it is them who supply the real money, **M/P**, to the market. However, it would still not explain why the money demand, **Md(Y,r)**, is inversely related to **r**, which is the interest rate. As far as I can tell, the interest rate will only reduced the money lay dormant in the hands of either households or firms.  
> **username_0**: in other words, the total money demand has two aspects: **Me**, denoting the money in circulation and **Ms**,the money in dormant. Clearly, **Me** is positively related to Y, GDP, as the increase of productivity spike the amount of transaction ,and **Ms** is negatively related to interest rate as higher interest rate would encourage people opting to bonds, so that **the debtor would invest the money from bond sales into circulation**.  
> **username_0**: The key point is that even if **Ms** decreases because of bond sales **Me** would most like increase from these sales, as bonds only function as a money transfer in this sense, so the aggregate demand **Md(Y,r)** remains constant. Then although interest rate is inversely related to **Ms**, it does not imply **Md(Y,r)** is inversely related to interest rate as well, unless we define **Md** as **Ms**.  
> **username_0**: If we do not complicate the issue and just analyze the impact of **Y**,GDP, on interest rate, It is clear that if money supply is kept at constant, an increase in Y will result an up in **Me** and thus less **Ms** for bond trading; This effectively increase the value of money and thus increase the interest rate. This is, in my opinion, the natural or reasonable way of interpreting the LM curve but all the literature I found invariably claim a negative relationship between **Md** and **r** which makes no sense to me at all.  

---

