Suppose a computer virus disables the nation’s automatic teller machines, making withdrawals from bank accounts less convenient. As a result, people want to keep more cash on hand, increasing the demand for money.
a. Assume the Fed does not change the money supply. According to the theory of liquidity preference, what happens to the interest rate? What happens to aggregate demand?
b. If instead the Fed wants to stabilize aggregate demand, how should it change the money supply?
c. If it wants to accomplish this change in the money supply using open-market operations, what should it do?