Suppose the Central Bank conducts an open market purchase.
a) Show the effects of this on the bond market and money market by drawing a supply and demand diagram for each. Assume the liquidity effect is the only effect.
b) Looking at your diagram, immediately after the open market purchase (i.e. after the shifts you drew in the diagram but before the markets are at the new equilibria) would there be excess demand or excess supply in the money market and the bond market? Briefly explain.
c) Suppose in addition to the liquidity effect, there is a price level effect in this market. Briefly explain how the open market purchase would eventually affect the money market due to the price level effect.