(a) Assume that initially Money Supply is equal to $100 bn., cash reserves are equal to $25bn, and the required reserve ratio is equal to 0.25. By how much will Money Supply change if cash reserves increase by $5 bn.? Do you think this increase is realistic?
(b) Explain what the $5 bn. increase in cash reserves will do to GDP under the following assumptions:
i. Each $1 bn. increase in cash reserves reduces the interest rate by 0.5 percentages point (i.e., for example, from 0.05 to 0.045 (from 5% to 4.5%))
ii. Each 1 percentage point decline in interest rates stimulates $30 bn. worth of new investment
iii. The spending multiplier is 2
iv. The AS curve is horizontal, i.e. the above spending multiplier takes its full effect
(c) Below you find several incidents that are the consequence of shifts in either Money Supply or Money Demand. First, tell me whether the instance is due to a Supply or Demand shift. Second, state which specific shifter is responsible for the incident at hand. Lastly, tell me what effect the respective shift has on the interest rate.
i. Firms recognize that loans have become cheaper recently
ii. People engage in more transactions
iii. The amount of bonds in the money market increases even though no new bonds have been issued recently
iv. Firms were forced to cut back the volume of loans.