Assignment

Question 1: For each of the following reserve requirements, calculate the simple money multiplier (i.e., the money multiplier when people do not hold any currency), and then re-calculate the money multiplier for each case if the ratio of individuals' currency holdings to their deposits is 10%. Show all your calculations.
a) 15%
b) 20%

Question 2: Suppose the current money supply is $20,000. The reserve requirement is 0.10. The Fed wants to decrease the money supply by $1000. Assume that banks do not hold excess reserves and individuals hold no currency.

Determine the following:

a) the money multiplier

b) the monetary base

c) the amount by which the Fed must change the reserve requirement to achieve the stated desired change in the money supply. (What should be the new reserve requirement ratio?)

d) If the Fed decides to use an open market operations tool instead, would it have to buy or sell bonds to achieve the stated desired change in the money supply, and by how much would it need to buy or sell bonds?

Question 3: Suppose that the money market in Eastlandia is initially in equilibrium and the central bank decides to increase the money supply. Using a diagram for money market, explain what will happen to the interest rate in the short run.

Question 4: An economy is in long - run macroeconomic equilibrium with an unemployment rate of 7% when the government passes a law requiring the central bank to use monetary policy to lower the unemployment rate to 4% and keep it there. How could the central bank achieve this goal in the short run? What would happen in the long run? Illustrate with a diagram.