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Real money demand function

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Reference no: EM133124479

Consider the IS-LM model with completely sticky goods prices in the SR closed economy. Suppose the consumption function is given by C=100+0.8*(Y-T) and the investment function is given by I=600-5000*r. G=800 and T=500. Money supply M=25000 and general price level P=5. The real money demand function is given by L(i,Y)=0.2Y/i. =2% in the Fisher equation.

  1. Derive the equations of the IS and LM curves and solve for the equilibrium real output, real interest rate, consumption and investment spending.
  2. Consider a one-time open market sales of bonds of 100 by the Bank of Canada (to a private bank). Suppose all private banks have the same reserve ratio of 4% and the general public's cash-to-deposit ratio is 0.

i. After all (infinite) rounds of "money creation/destruction", show the changes in the balance sheets of the private banking system, the Bank of Canada and the general public. By how much does the money supply increase/decrease?

ii. Use the IS-LM model with completely sticky goods prices to graph the impact of such open market sales in the SR closed economy. How will equilibrium real output, real interest rate, consumption and investment spending change? Explain. (DO NOT solve numerically.)

Reference no: EM133124479

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