Question

4) The demand for money is given by Md $YL(i), where L(i)- (3/10-i), $Y 120 and the supply of money Ms is a quarter of $Y a. What is the equilibrium interest rate? b. If the central bank wants to decrease i by 2 % , at what level should it set the supply of money? c. If the people hold 25% in cash and the rest of the money in demand deposits with the banks holding 20% in reserve requirements what would be the H supply of high powered money.

Answer 1

Md = Y * L(i)

Ms = Y / 4

L(i) = [3/(10-i)]

Y = 120

(a) Equilibrium interest rate is when Demand of money = Demand of supply

Md = Y * [3/(10-i)]

Md = 120 * [3/(10-i)]

Ms = 30

For equilibrium interest rate, Md = Ms

120 * [3/(10-i)] = 30,

solving for i gives -2%

(b) If Fed reduces interest rate by 2% which makes interest rates as -4%

L(i) would be = [3/(10+4)] = 3/14

Md would be 120*(3/14) = 25.71, that should be equal to supply of money

(c) If Ms = 30, people holds 25% in cash which is 7.5 and 20% in reserve which is 5. So high powered money is people holding money + reserve holds by banks. So high powered money is 12.5