One of the banking innovations in the 1960s was the payment of interest on certain types of demand deposits. Assume that interest is paid on money at the nominal rate Rm, which equals (R - x), where x is the nominal return on bonds, which is exogenously determined by market structures and the cost of servicing  deposits.

(i) Use Baumol's transactions demand model to derive the demand function for money.

(ii) Generalizing the above demand function to md(y, R, x), shows the behavior of the LM curve for shifts in x and P.

(iii) What is the effect of an increase in x on aggregate demand, output and price level in the neoclassical model?

(iv) Assuming that both R and x always increase by the expected rate of in?ation, do (ii) and (iii) again.