Question

Suppose a closed economy is initially in the long run equilibrium. Suppose the monetary base of this economy is $100 million, of which people carry $10 million in form of currency/cash.

3. Assuming the banks keep a reserve ratio of 5%, what is the money supply in this economy?

Suppose from now on that because of a virus, people become afraid of using currency and decide to deposit all the currency in banks, and carry money exclusively in the form of demand deposits.

4. What happens to the money supply?

5. Use the IS-LM model to illustrate the short run impact of this change in money supply on the equilibrium level of GDP and interest rate. Use a diagram and also explain in words. Make sure you show which curve shifts, and in which direction.

6. Assuming the fiscal and monetary policymakers do not do anything, what will be the long run level of GDP and interest rate? Use the same diagram you already drew to answer question 5. Make sure you show which curves shift, in what direction and what causes the shift.

7. Assuming the government decides to stabilize output, what kind of fiscal policy should it use? Illustrate the effect on GDP and interest rate in the same diagram you drew to answer questions 5 and 6.

8. Assuming the government decides to stabilize the interest rate, what kind of fiscal policy should it use? Illustrate the effect on GDP and interest rate in the same diagram you drew to answer questions 5, 6 and 7.

PLEASE ANSWER QUESTION 5 6 7 AND 8

Answer 1

solution :- 3) Given that Monetary bases $100 million Monetardy Rage = currency + Deposits 10% Deposits 100-10 = $90 millone 100 .. Deposits (currency -Deposit L= lo =Ooll 90 re = 50). RR Deposits Money supply = (Money Multiplier x (Monetary Base こ (2+1) X MB 0-11+) Oollto.o5 100million X TOOM: 0.16 Money supply = $693-75 million