Question

suppose you have the following information
original money demand
md=P×[200+.5Y-200i]
where p=1(p remains constant in problem)
y=1600
ms=600
MB=400
MM=1.5
solve for nominal interest rate that clears money market
draw a money demand money supply diagram depicting these initial conditions
we now experience a portfolio shock to money demand so that the new money demand function is Md=P×[400+.5Y-200i]
solve for the new market clearing interest assuming there is no change in the money supply and label as point b
assuming the fed wanted to keep the interest rate constant what would they need to do
redraw a money demand and money supply diagram showing initial condition and label as point a
instead of a portfolio shock to money demand we experience a shock to money multiplier. MM falls and is now .8 it was 1.5. assuming the fed does nothing what is the new money market clearing interest rate. label point b on diagram
now assume fed is proactive and responds to the money multiplier shock immediately to keep interest rates at initial level. what would the fed have to do exactly in terms of open market operations (show work) and label this as point c on your diagram

econ 104 psu

Answer 1

a. Money market clears when money demand is equal to money supply.

Md=P(200+0.5Y-200i)=Ms=600

0.5*1600-200i=400

i=400/200=2%

b. If money demand function changes to Md=P[400+.5Y-200i], then Md=Ms gives

400+0.5Y-200i=1600

i=600/200=3%

c. If MM changes from 1.5 to 0.8 , then money supply Ms changes to 0.8*400=320. Now money market will be at equilibrium when P(200+0.5Y-200i)=320,

800-200i=320-200

i=(800-120)/200= 3.4%