The economy, however, is facing inflationary pressures. To deal with the macroeconomic problem, the government uses expansionary fiscal policy to decrease taxes and, as an indirect effect, the currency/deposit ratio (cd), decreases by 10%. Given the above information,
(i) Find the monetary base and calculate the percentage changes in the equilibrium values of the narrow (M1) and broad money (M2) supplies as a result of the government's policy stance. Explain and illustrate your answers with the appropriate diagrams, where necessary.
(ii) Calculate the percentages changes in the equilibrium values of both the narrowly-defined and broadly-defined money supply if the central bank had used instead both quantitative easing and an expansionary monetary policy by purchasing private sector and federal government securities in the financial market worth $20million. Explain and illustrate your answers with the appropriate diagrams, where necessary.
(iii) Which of the two policies will have the most effect on the equilibrium interest rate? Why? Explain and illustrate your answers with the appropriate diagrams, where necessary.
(iv) If both policies are used simultaneously to deal with the problem in this economy, calculate the percentage changes in (a) the monetary base; (b) total bank deposits; (c) total currency holding of the non-bank public; (d) total bank reserves; (v) the deposit multiplier; and (vii) the money multiplier.
(v) What will be the likely effect of a sudden increase in expected inflation on the money supply of this economy? Explain carefully.