Reference no: EM133439557

1. Suppose that the Central Bank has currently set the reserve...

Suppose that the Central Bank has currently set the reserve requirements in the economy to be equal to 10%. Assume that there is no cash drain. Suppose also that in the economy there are $400 in initial deposits and $6,000 of cash.

Given the above, what is the total Money Supply (MS) in the economy?

Now suppose that the economy's demand for money (MD) is given by the following equation:

MD = 12,000 - 1,000r
Where r is the interest rate in integers (e.g. at a 2% interest rate, r = 2).

2. What is the equilibrium quantity of money (M) and interest rate (r) in the economy?

Now suppose that the Central Bank wants to close an output gap in the economy, and wants to raise the interest rate by 2% to do this. Assume that the Central Bank targets the Money Supply directly.

3. If the Central Bank is raising rates, then what type of output gap is the economy likely to be in? Explain your answer using the AD-AS model. Why does raising interest rates close the output gap?

4. If the Central Bank wants to change the Money Supply by changing the quantity of cash in the market in order to achieve the interest rate increase, how much does it need to change the quantity of cash? [Note: the question here is asking about the cash balance, which begins at $6,000, not the total Money Supply]

5. How much would the Central Bank need to change these reserve requirements to achieve the necessary change in the Money Supply to raise these interest rates by 2%?