Suppose that rather than immediately lending out all excess reserves, banks begin holding some excess reserves in response to uncertain economic conditions. Specifically, banks increase the percentage of deposits held as reserves from 10% to 20%. This increase in the reserve ratio causes the multiplier to fall from 10 to 5. Under these conditions, How Many Dollars Worth of government bonds would the Fed would need to Buy or Sell in order to increase the money supply by $100?

2. The theory of liquidity preference and the downward-slopingaggregate demand curve The following graph shows the money market in a hypothetical economy. The central bank in this economy is called the Fed. Assume that the Fed fixes the quantity of money supplied. Suppose the price level decreases from 90 to 75. Shift the appropriate curve on the graph to show the impact of a decrease in the overall price level on the market for money. 12 Money Supply 10 Money Demand Money Supply MD1 2 MD2 10 20 30 40 50 60 MONEY (Billions of dollars) INTEREST RATE (Percent)

(Principles of Economics 11th edition page 568, Chapter 26, Problems 7) Illustrate the following situations using supply and demand curves for money : a)The Fed buys bonds in the open market during a recession b)During a period of rapid inflation, the Fed increases the reserve requirement c)The Fed acts to hold interest rates constant during a periodof high inflation d)During a period of no growth in GDP and zero inflation, the Fed lowers the discount rate  e)During a period of rapid real growth of GDP, the Fed acts to increase the reserve requirement

Changes in the money supply The following graph represents the money market for some hypothetical economy. This economy is similar to the United States in the sense that it ha a central bank called the Fed, but a major difference is that this economy is closed (and therefore does not have any interaction with other world economies). The money market is currently in equilibrium at an interest rate of 4% and a quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol. INTEREST RATE (Percent) 6.0 5.5 5.0 45 4.0 35 3.0 25 20 0 Money Demand 0.1 Money Supply 0.2 03 0.4 0.5 0.6 0.7 MONEY (Trillions of dollars) 08 4 New MS Curve New Equilibrium Ⓒ image 1 Suppose the Fed announces that it is lowering its target interest rate by 75 basis points, or 0.75 percentage points. To do this, the Fed will use open- market operations to the money by the public. Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by placing the…