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Exercise: Money market

 

Assume that you have the following information about the Dm and Sm curves:

If the RRR is 15%, find the maximum effect on the money supply when the Fed buys a quarter of a million dollars worth of bonds from commercial banks. What is the new nominal interest rate at equilibrium?

  • Calculate the original equilibrium nominal interest rate:
  • Calculate the maximum effect from the Fed's action:
  • Find the new Sm curve (assuming max effect):
  • Find the new nominal interest rate at equilibrium:

Let's graph that:



Now assume that the expected inflation is supposed to be 0.2%, find the effect of the central bank on the loanable funds market (just show the effect on the demand curve). What is the old and new real interest rate at equilibrium.


Let's graph that:



Finally describes the impact of the Fed's action on the AD/AS model in the short run.
  • The variable I (for investment) goes up which implies that the aggregate demand curve shifts to the right. Putting upward pressure on the price level, and increasing the level of employment and output. This is an example of an expansionary monetary policy.

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Location: Boston, MA, USA

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