1. Suppose the banking system in an economy looks like this after an open market operation:
ASSETS LIABILITIES
Reserves $2B | DD $10B
Loans $4B |
Bonds $4B |
and the reserve requirement is 10%. If banks never hold any excess reserves, and people never hold any cash in their pocket, how much would the money supply increase?
Suppose banks always keep excess reserves of 2% of their demand deposits. How much would the money supply increase in that case?
2. Under normal circumstances, how would the open market operation that was used in question one affect interest rates? What is the path through which this monetary policy affects GDP?
3) Suppose the economy is at full employment and the government increases spending. What will happen to long run real output and prices? What could the Federal Reserve do to the money supply (increase, decrease) if it wanted to prevent that change in prices? If the Fed undertook this preventative policy, they wouldnt announce that they were changing the money supply. What would the Fed (specifically the FOMC) announce they were doing?
