This says that consumers hold 20% (c = 0.2) of their money as currency and the required reserve ratio is 37.5% (θ = 0.375). Demand for central bank money (Hd) is the total amount of currency being demanded plus the total demand for reserves. Suppose the price level is P = 1 and that the initial supply of central bank money is $100.
a. Solve for the money multiplier. Explain your work.
b. Solve for equilibrium output and the equilibrium interest rate at the initial supply of central bank money (ie. $100).
c. Suppose that the central bank sells $80 worth of bonds using open market operations. Solve for the new equilibrium output.
d. Solve for the new equilibrium interest rate after the open market operations and use an IS-LM graph to explain what happened.