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Problem:
Consider the model of supply and demand for central bank money. Assume that there there are commercial banks. Suppose that people hold 20% of their money in currency and 80% of their money in deposits. The central bank sets the reserve-to- deposit ratio at 10%. In the first period, the central bank increases the supply of money by $200, buying bonds through Open-Market Operations. Use this information to answer the following questions:
(a) For the second period (after the central bank has injected $200 in the economy), calculate: (i) the demand for currency, (ii) the amount of deposit held at the commercial banks, (iii) the demand for reserves held at the central bank, and (iv) the demand for the high-powered money. How much is the additional money supply created at the end of the second period?
(b) How much is the additional money supply created at the end of the third period?
(c) As time continues, additional money supply will be created. Calculate the total increase in the money supply as a consequence of the initial $200 increase in the money supply by the central bank.
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