Question

a) In an open-market purchase, the Reserve Bank ____ government bonds and the supply of bank reserves ______.

A. buys; increases

B. buys; decreases

C. buys; does not change

D. sells; increases

b) If inflation does not adjust rapidly in the short run, then when the Reserve Bank increases the nominal interest rate, in the short run the real interest rate will:

A. increase

B. decrease

C. not change

D. equal the nominal interest rate

c) If planned aggregate spending in an economy can be written as PAE = 28 000 + 0.4Y – 40 000r, and potential output equals 44 000, what real interest rate must the Reserve Bank set to bring the economy to full employment?

A. 0.02

B. 0.03

C. 0.04

D. 0.06

Answer 1

a) A. buys; increases. Because there is an open market purchase the central bank in the country purchases Government Bonds and in exchange it provide commercial banks the necessary reserves which increases the supply of Reserve the banking system

b) A. increase. Reserve Bank increases the nominal interest rate but inflation is not increased rapidly. Then the real interest rate will increase because real interest rate = nominal interest rate - rate of inflation

c) C. 0.04 is correct. At equilibrium

44000 = 28000 + 0.4*44000 - 40000r

-1600 = -40000r

r = 4%