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Consider the central bank balance sheet fort he country of natureland. Natureland currently has 1,800 million dollars in its Money supply, 1,100 million of which is backed by domestic government bonds; the rest is backed by foreign exchange reserves. Assume Natureland maintains a fixed exchange rate of 1 dollar per euro, the foreign interest rate remains unchanged, and Money demand takes the usual form. Assume prices are sticky.
Question a. Show Natureland's central bank balance sheet, What is the backing ratio?
Question b. Suppose central bank sells 200 million in government bonds. Show how this affects the central bank balance sheet. Does this change Money supply ? Explain why or Why not, what is the baking ratio now ?
Question c. Suppose that real income contracts by %10 . How will this affect Money demand in Natureland? How will forex traders respond to this change?
Question d. Using new balance sheet, show how the change described in part c affects Natureland central bank. What happens to domestic credit ? what happens to foreign reserves?
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