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In country Z, the required reserve ratio is 10 percent. Assume that the central bank sells...

In country Z, the required reserve ratio is 10 percent. Assume that the central bank sells $50 million in government securities on the open market.

(a) Calculate each of the following.

(i) The total change in reserves in the banking system

(ii) The maximum possible change in the money supply

(b) Explain the impact of the central bank’s bond sale on the nominal interest rate.

(c) What is the impact of the central bank’s bond sale on the equilibrium price level in the short run? (d) As a result of the price level change in part (c), are people with fixed incomes better off, worse off, or unaffected? Explain.

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Answer #1

Part a) the total change in reserves in the banking system would amount to $ 50Mn.

Part B) The reserve ratio requirement = 10 %

The maximum possible change in money supply = Change in reserves / reserve ratio = $50Mn / 10% = $500

Part C) The central bank's bond sale would affect the equilibrium level price, thus making it fall. This will reduce the nominal interest rate.

Part D) This fall in prices would lead to an increased real income level of the people with fixed incomes, thus making them better off as they will now have a higher purchasing power.

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