Damping effect

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Damping effect
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Dampenining effect is the effect of the central bank's pursuit of a monetary policy of an expansive nature, which is characterized by increasing the money supply by affecting the money and commodity markets.

Equilibrium on the money market in the initial situation is present at point E1 at a given interest rate r1. On the other hand, the commodity market is balanced at a given level of income Y. When the money supply increases, the money supply curve shifts to the right, ie from the position M1 (S) to M2 (S). Then, the new equilibrium on the money market is achieved at the interest rate r2. The new, lower interest rate increases the investment and consumption demand. The graphic consequence of this increase is the shift of the AD1 function to AD2. The new balance on the commodity market is achieved at Y2 income level. The increase in income affects the increase in money demand and the curve M1 (D) shifts to M2 (D). At the interest rate r3, a new balance on the money market will be achieved. Increasing the interest rate reduces the investment and consumption demand. The aggregate demand curve is shifted down from position AD2 to curve AD3. Then, at level Y3, there is a new balance point on the E3 commodity market.

The attenuation effect can also be written as follows:

MS ↑ => r ↓ => I + C ↑ ↑ => AD ↑ => Y => MD ↑ => r ↑ => C ↓ ↓ + I => AD ↓ => Y ↓

The suppression effect is mainly due to the fact that the increase in the money supply affects the reduction of the interest rate and increases the production, which translates into an increase in interest (which reduces production and dampens aggregate demand).

Determinants of the damping effect

a gradual increase in income stimulated by a drop in the interest rate demand for money depending on interest rate and income.