The firm in the world economy
The chapter concerns the supply and demand for money and the determination of the equilibrium interest rate within a domestic economy. Having defined both the supply of money and the demand for money, the chapter combines these two relationships in the money market to determine the equilibrium price of money or the interest rate. The changes in the equilibrium interest rate translate into changes in the country's exchange rate. The chapter examines the relationship between interest rates and the exchange rate, and how changes in interest rates, the exchange rate, the current account, and the financial account all interact with one another. To determine how money affects the exchange rate, the first objective is to define the term money. Changes in the money supply cause interest rates to fluctuate, which in turn influences exchange rates and the balance of payments. The chapter shows that what would tend to happen to the exchange rate if interest rates suddenly changed.