Therefore, in order to prevent him from being perceived as the Great Oz, I will play the role of Toto and pull away the curtain in front of the LM curve. Keynes believed that the quantity or stock of money played a key role in determining the equilibrium interest rate. The bonds pay a return or yield of R . First, given a level of disposable income, households choose their amounts of consumption and savings independent of the real interest rate. Second, the households make their portfolio decision by allocating their accumulated saving or real wealth between real money and bonds.
P b is that price which equates the demand for bonds with the existing supply of bonds.
Since there is only one type of bond, the equilibrium bond price determines one and only one corresponding yield or real interest rate R . The yield or return on an asset, like a bond, is inversely-related to its price. P b and its corresponding is shown on the diagram. Therefore, once you decide your optimal level of bonds, you automatically choose your optimal holdings of real money. Therefore, according to Keynes, the equilibrium short-run real interest rate R is that rate which simultaneously clears or equilibrates both the money and bond markets.