Consider the following Keynesian closed economy model. Real money demand:
Full-employment output: Nominal monetary base: Currency-deposit ratio:
rate Y = .6/(.001) - r/(.001)
(a) Suppose that the reserve-deposit ratio is res = 0.1 and that the economy is in long- run equilibrium.
(i) What is the value of the money multiplier? (ii) What is the value of the nominal money supply? (iii)What are the nominal values of deposits, currency, and reserves? (iv)What is the value of the real interest rate in long-run equilibrium?
Hint: You know full employment output. What interest rate equates the aggregate demand for goods to the aggregate supply for goods? (v) What is the value of the price level in long-run equilibrium?
Hint: You know full employment output and the money supply. What does the
price level have to be so that the money market is equilibrium? (vi)What is the value of velocity in long-run equilibrium?
(b) Suppose that, as a result of a financial crisis, banks become reluctant to make loans and they want to increase their reserve holdings relative to deposits. Specifically, the reserve-deposit ratio increases to res = 0.7. For parts (i)-(iv), the central bank maintains the value of monetary base equal to 960.
(i) What is the new value of the money multiplier? (ii) What is the new value of the nominal money supply? (iii)Suppose that the price level remains fixed at the value you found in (a) part (v).
Given the new value of the nominal money supply, what are the short-run
equilibrium values of output and the real interest rate? (iv)What is the new long-run equilibrium value of the price level? (v)
Now suppose that the central bank wants to maintain output and the price level
at their long-run equilibrium values (that you found in part (a)). What do they have to set the monetary base to in order for this to occur?