Question

1. Bangladesh Bank increased the Cash Reserve Requirement (CRR) from 5.5% to 6% on December 15, 2010. On that day Call Money Rate shot up to 175%! How do you explain this abrupt change in call money rate? Explain how this change in CRR may affect the equilibrium price level and output of the economy in the short run and the long run. Show graph.
2. Assume that the economy is currently in short-run equilibrium. Use words and diagrams to describe what will happen to equilibrium price and equilibrium output in the following case: Consumers are expecting a higher price in future and at the same time nominal wage rate increases. (Hint: Two forces are at work simultaneously. Use AD and SRAS to explain your answer. You do not need to worry about LRAS)

3. Suppose the self regulating economy is in long-run equilibrium. Now, government increases its expenditure (G). Draw a graph to show what will happen to equilibrium output and price level in the short run and in the long run. Carefully label your graph and briefly explain your graph with words.

Answer 1

1.The sources of fund for banks and financial institution Call money market has become very imporatnt sources of finance whenever there has been liquidity crises arises. It become a lifesaver for most of the financial institutions that have backed on low stability and low rates and urgency for requirement of funds.However, from December 2010, the call money market has been experiencing great instability and the rates have been extremely volatile and very high.

The money market has been suffering from liquidity crisis from December 2010 with the government making huge withdrawals from the market. One reason the government has borrowed so heavily from the money market is to curb inflation.

The call money market has also allowed banks and NBFIs(Non- banking finanacial Institutions) to borrow at very low cost. Banks have borrowed short term from the call money market to fund investments over a year believing that they would be able to acquire funds anytime and at very low cost.

The liquidity crisis in the money market worsened with Bangladesh Bank’s circular issued for banks to immediately meet their mandatory 6  per cent Cash Reserve Ratio (CRR) deposits at the central bank with foreign exchange. Moreover, Bangladesh bank has increased cash reserve requirement from 5% to 6%. Banks now have to keep aside a greater portion of their funds for the central bank and hence can participate less in call money market All these resulted in total crisis in the market and the call money market has become quite erratic.

2. Shifts in the SRAS which represents the best and the worst outcome of the economy.If SRAS increase we end up with the lower price, less unemployment and more output. On the other hand, decrease in SRAS result in increase in price, more unemployment and less output.