Reference no: EM13183133
1. Let's go back to the fall of 2008 when we were at the height of the financial crisis. Pretend you are steering the cruise ship and your goal is to keep interest rates steady in the money market.
For simplicity, we hold the price level fixed at 1 and assume that inflationary expectations are fixed at 2%.
Initial Conditions before the fall of 2008
mm = money multiplier = 1.6
MB = monetary base = 3000
Money Demand
Md = P X [ a0 + .5 (Y) - 200 (i) ]
Md = 1 X [ 2600 + .5 (5600) - 200 (i) ]
Solve for the money market clearing rate of interest (show your work on your exam sheet). Now draw a money market diagram labeling this initial equilibrium in the money market as point A on your exam sheet.
2.We now experience a shock to the money multiplier so that the new value of the money multiplier is now 0.8. Given that we are in the fall of 2008, what caused such a shock to the money multiplier?
3.In addition to the shock to the money multiplier as in Question 15, we experience two more shocks that influence the money demand curve: The new, money demand curve is now equal to:
Md = 1 X [ 2900 + .5 (5400) - 200 (i) ]
Explain why we would expect this to happen to the money demand function during the fall of 2008. Be sure to discuss both of the shocks to money demand.
4.Given that your job is to keep interest rates constant at their level in Question 14, what must you do in terms of open market operations given the shock to the money multiplier and the two shocks to money demand? Show all your work on your exam sheet.
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