Question

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.

1. What happens to the money supply?

2.It sometimes happens that during a severe recession the unemployment rate decreases a bit long before the economy recovers. Why does that happen?

3.Consider the Solow model with exogenous growth. Assume that because of global warming the depreciation rate increases. Illustrate the change in the steady state. What happens to the growth rate of standard of living in the new steady state?

Answer 1

Question 1

It has been stated that because of the fear of catching virus by touching the currency notes, people has reduced their use of currency and has deposited all their currency in banks in their demand deposits and using these demand deposits as means of carrying money and undertaking transactions.

This means currency in circulation will decrease while demand deposits will increase. Since, currency in circulation is being deposited into demand deposits, the decrease in currency in circulation would be equal to the increase in demand deposits.

Both currency in circulation amd demand deposits are part of money supply.

So, a decrease in one (currency in circulation) and increase in another (demand deposits) by same magnitude will keep the money supply unchanged.

Thus,

The money supply will not change.