Question

mm = money multiplier = .8
MB = monetary base = 2500
Money Demand: M_d = P X [ a₀ + .5 (Y) - 200 (i) ]
where: a₀ = 800, Y = 4000

For simplicity we hold the price level fixed at 1 and assume that inflationary expectations are fixed at 2%. Y is also held constant in this problem.

1）What is the equilibrium interest rate (i)?

2）Suppose a₀ falls to 600. What is the new equilibrium interest rate?

3）Suppose that the Fed wanted to keep interest rates constant at their initial level (the value you found in #1). What would the Fed have to do in terms of open market operations to achieve this?

4）Given the interest rate you found in #2, what is the ex-ante real interest rate?

Answer 1