The equilibrium interest rate is the point at which the quantity of money supplied equals the quantity of

money demanded. This is shown in the graph as r*. This means that r* is the interest rate that will prevail
under the money supply and money demand conditions for the economy illustrated in the graph.

At the equilibrium interest rate, the quantity of money demanded equals the quantity of money supplied.
At any other interest rate, this condition does not hold and, in the money market, it will force the interest
rate to the equilibrium level.

For example, if the interest rate is temporarily above the equilibrium level, there will be an excess supply
of money. Recall that at high interest rates, people are more likely to hold financial assets in interest-
bearing securities. When the interest rate is above the equilibrium level, there will be more money
available than people wish to hold. Interest rates must fall to encourage people to hold more money and
fewer bonds. One way to look at this is an excess supply of money means there is that an excess
demand for bonds. This causes the price of bonds to rise, which drives down the interest rate.

If the interest rate is below the equilibrium rate, there will be an excess demand for money. Because
people want to hold more money than there is available, people will try to sell bonds in order to increase
their money holdings. This drives down bond prices and causes interest rates to rise.

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