Question

The real money demand curve is given by: L d (R, Y ) = 0.5Y − 100R − 20 where Y is the real GDP and R refers to the interest rate. The initial monetary base level MB = 100. The initial money supply level Ms = 200, price level P = 10 and initial output level Y = 100. 1. Calculate the initial money multiplier and equilibrium interest rate. The Fed increases the monetary base by 10% through open market purchases. Assuming the money multiplier is still 2. Suppose that real GDP, price, and ination expectations are unaected by monetary policy. Find a new interest rate in the short-run. In the long run, price increases as much as the increase in the money supply. The monetary policy promotes corporate investment and increases government spending. Thus, a new real GDP Y = 110 in the long run. Find a new interest rate in the long run.During a recession, the monetary base increased as the outcome of an easing monetary policy. Banks are hesitant to lend money, which increases the excess reserve ratio. Thus, assume that the Fed increases the monetary base by 10% from the initial monetary base level MB = 100 whereas money multiplier rather decreases from 2 to 1. What happens in the short-run interest rates in this case? Again, we assume that real GDP, price and ination expectations are unaected by monetary policy in the short-run.. Compare the eect of the monetary policy on the short-run interest rates with and without changes in the excess reserve ratio.

Answer 1