In the short run, an increase in the money supply will push the interest rate down as money demand fluctuations alter people's desire for liquid assets and thus the prices and rates of return on bonds. In an open economy where interest parity between countries must be preserved the exchange rate will increase (currency depreciation) in order to create the expectation that it will fall faster in the future. This increase in the exchange rate makes domestic goods more attractive, thus increasing both foreign and domestic demand for domestically produced goods. This then encourages output growth. In the long run it will depend on whether the money supply increase is deemed to be permanent or temporary. Unless the change is permanent effects in the long run will not be felt. If the change IS permanent, the following will happen: - As money supply increases, the short run effects described above will mean that output is pushed above its natural level. However, as output is above its natural level, this means that workers and machines are working overtime (AA curve shifts right). In the short run it increases due to an increase in the money supply, but then it decreases in the long run as the real money supply is reduced by price increases over time. However it will not go back to its original level. It will be higher by the same percentage as the money supply has been increased by. Monetary policy has different effects in the short run and the long run. Expansionary monetary policies designed to reduce short-term interest rates and spur full employment and economic growth eventually lead to higher interest rates as they induce inflation. This means that monetary policy must be carefully applied. If the Fed introduces a monetary stimulus, they must also plan to remove the stimulus in order to prevent future inflation. The problem for policymakers is in timing the policy.