Question

Assume that the following conditions​ exist:

a. All banks are fully loaned​ up- there are no excess​ reserves, and desired excess reserves are always zero.

b.

The money multiplier is

5.

   

c. The planned investment schedule is such that at a 4 percent rate of​ interest, Investment

​=$1520

billion. At 5​ percent, investment is

​$1510

billion.

d. The investment multiplier is

3.

e..

The initial equilibrium level of real GDP is

​$13

trillion.

f. The equilibrium rate of interest is 4 percent

Now the Fed engages in contractionary monetary policy. It sells

​$1

billion worth of​ bonds, which reduces the money​ supply, which in turn raises the market rate of interest by 1 percentage point.

Calculate the decrease in money supply after​ FED's sale of​ bonds:

​$nothing

billion.

Answer 1

Answer :-

The simple money multiplier can be defined as the change in money supply due to the initial change in deposit through the open market operation.

For a $1 change in initial deposit through open market operation decreases the money supply by $5

Therefore, due to a decrease in deposit $1 billion through the open market sale of the bond will decrease the money supply by M^s

M^s = $1 billion x 5 = $5 billion

Thus, after FED's sale of bonds, money supply will decrease by $5 billion.

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