1. Use the following information to answer the next four questions. Each multipl

Question

1. Use the following information to answer the next four questions. Each multiple choice question is worth 3 points.

mm = money multiplier = .8

MB = monetary base = 3000

Money Demand: Md = P X [ a0 + .5 (Y) - 200 (i) ]

where: a0 = 1000, Y = 3600

For simplicity we hold the price level fixed at 1 and assume that inflationary expectations are fixed at 2%. Y is also held constant in this problem. What is the equilibrium interest rate (i)?

2%

2.5%

None of the above are correct

3%

1%

2. Suppose a0 falls to 800. What is the new equilibrium interest rate?

1%

3. Suppose that the Fed wanted to keep interest rates constant at their initial level (the value you found in #1). What would the Fed have to do in terms of open market operations to achieve this?

4. Given the interest rate you found in #18, what is the ex-ante real interest rate?

Explanation / Answer

1) The answer is --) 2%

because MD = P* ( a0 +0.5(Y) - 200 i )

2400 = 1 * ( 1000 + 1800 - 200i)

2400 = 2800 - 200i

2400 -2800 = 200i or i = 2%

2) The answer is -- 1%

when a0 falls to 800 . then

2400 = 2600 - 200 i

-200 = - 200 i

i= 1%

3) The asnwer is D--- 250 in open market purchases.

because we have mutliplier 0.8 . so purchase securties in open market by 250 will increase a0 back to 1000. because 200 / 0.8 = 250 .

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