Reference no: EM133339887

Case: In a hypothetical economy with a competitive banking system in which banks produce only demand deposits, the narrow money supply (M1) in existence is $1750 million; the idle excess reserves drain coefficient (e ) is 3%, the customary cash reserve ratio (r ) for demand deposits is 8%, and the currency/deposit ratio (cr ) is 30%. Using the multiplier model discussed in class or chapter 15 of the textbook, determine and calculate: (i) the equilibrium level of the monetary base (MB); (ii) the equilibrium level of demand deposits (D); (iii) the total amount of desired cash reserves held by banks (BCR), the amount of currency (C )held by the non-bank public; (iv) the amount of bank loans (BL and the values of the deposit (dm) and money multipliers (mm). Use diagrams to ILLUSTRATE your answers, where necessary.

The economy, however, faces a situation of unemployment pressures. To alleviate these pressures in the economy, the monetary authorities implement a macroeconomic policy package (consisting of both expansionary monetary policy and expansionary fiscal policy) to increase the monetary base by 25% and reduce taxes which, in turn, causes the currency/deposit ratio to decline by 25%. Other things being equal, (i) calculate the percentage change in the equilibrium level of the money supply after the policy change and illustrate your answer with an appropriate diagram.

Lastly, assume that the money demand function in the above economy stays the same after the policy change. What is the expected short-run effect of the change in the money supply on the equilibrium interest rate? Explain carefully and illustrate with appropriate diagram(s).

Question: What is the expected short-run effect on the equilibrium levels of income, employment, and the exchange rate? Explain carefully and use diagrams to illustrate your answers, where necessary.