Reference no: EM13162224
Consider the following Keynesian closed economy model.
Real money demand: L = 0.2Y - 200r
Full-employment equilibrium output: Y* = 500
Nominal monetary base: MB = 960
Currency-deposit ratio: cu = 0.5
The aggregate demand for goods is a decreasing function of the real interest rate:
Y = .6/(.001) - r/(.001)
In this question the real interest rate r is written in decimal form. (I.e., if the interest rate is 5% then r=0.05.)
(a) Suppose that the reserve-deposit ratio is res = 0.1 and that the economy is in the long-run equilibrium.
(i) What is the value of the money multiplier?
(ii) What is the value of the nominal money supply?
(iii) What are the nominal values of deposits, currency, and reserves?
(iv) What is the value of the real interest rate in the long-run equilibrium?
(v) What is the value of the price level in the long-run equilibrium?
(vi) What is the value of velocity of money in the long-run equilibrium?
(b) Suppose that, as a result of a financial crisis, banks become reluctant to make loans and they want to increase their reserve holdings relative to deposits. Specifically, the reserve-deposit ratio increases dramatically to res = 0.7. For parts (i)-(iv), the central bank maintains the value of monetary base equal to 960.
(i) What is the new value of the money multiplier?
(ii) What is the new value of the nominal money supply?
(iii) Suppose that the price level remains fixed at the value you found in (a) part (v).
Given the new value of the nominal money supply, what are the short-run equilibrium values of output and the real interest rate?
(iv) What is the new long-run equilibrium value of the price level?
(v) Now suppose that the central bank wants to maintain short-run equilibrium output and the price level at their long-run equilibrium values (that you found in part (a)). What do they have to set the monetary base to in order for this to occur?
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