What is the result if the liquidity effect is grater than other effects in case of decreased money supply?

I got this question on the exam, In case of an increase in the money supply by the central bank what will happen if the liquidity effect is greater than the other effect (price level inflation... Effects) and the economy adjust slowly The answer would be that the interest rate will fall and rise slowly

The next question was what if the liquidity effect is greater than other effect and the economy adjust slowly in can of decreased money supply?

  • $\begingroup$ You'll need to document your question a lot more to make it more understandable and self-sufficient. $\endgroup$ – SRKX Dec 1 '15 at 2:45

Your question is quite confusing, and obviously not straighforward if you don't give more context. In fact, considering the simpler New Keynesian model several answers are possible depending on calibration.

The liquidity effect impact to an exogenous money supply shock can have several directions. Check the figures below from Gali (2001):

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  • $\begingroup$ In the normal case an increase in money supply increases liquidity effect and if the liquidity effect is greater than other effect like inflation effect then the interest rate will initially fall then rises by timw the economy adapts, but in the question the liquidy rises even though there's a decrease in money supply and i can't get how is that $\endgroup$ – Mohamed Amr Dec 1 '15 at 14:03
  • $\begingroup$ For me to understand what you mean by "normal case" I need you to tell me the parameterization of NKPC and IS curves and which Taylor rule you are assuming. Those are general statements that might not hold under trivial parameterizations. $\endgroup$ – phdstudent Dec 1 '15 at 14:48
  • $\begingroup$ I din't know any of what younare saying but i'll google a text of what i mean $\endgroup$ – Mohamed Amr Dec 1 '15 at 14:59
  • $\begingroup$ imgur.com/DYJNuPL i hope you know this diagram $\endgroup$ – Mohamed Amr Dec 1 '15 at 15:06
  • $\begingroup$ What i mean is the behavior of interest rate in case of money supply change $\endgroup$ – Mohamed Amr Dec 1 '15 at 15:10

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