Question

Suppose the market for money holding (meaning, the liquidity preference model) is in equilibrium at an interest rate of 8%. The reserve ratio is 5%.

(a) Depict this situation graphically.

(b) Suppose the Federal Reserve carries out an open market purchase of 120 million U.S. Treasury bonds. Depict the effect this will have in the market for money holding, showing

carefully the size of any shifts.

(c) Suppose instead, now, that interest rates were already at zero before the operation from part (b) was carried out; how effective will the open market operation above be at

stimulating aggregate demand? Explain, using the concept of the zero lower bound.

Answer 1