2. Escape from QE pre Covid19 Pandemic Consider the US economy a few years ago, in particular before the Pandemic in 2020. An important issue during that period was the possible scenarios and escape paths for the FED from quantitative easing. a. Because the economy was heating up, banks begin to reduce the ratio of reserves relative to deposits (i.e. they lend out a larger fraction of their deposits.) Describe and illustrate how this will affect (i) the money supply and (ii) aggregate demand (if at all). b. Assuming no policy intervention, describe what happens to inflation and output in the short and in the long run. c. Suppose that the FEDs objective is to stabilize the price level at the level prior to the economy heating up. Should it intervene in response to banks changing their lending decisions? How could the FED intervene via open market operations? d. In conjunction with open market operations, the FED decides to change the amount of interest it pays on reserves. How would it want to change the interest rate it pays on reserves? How would this affect banks' lending decisions?

Exploring Economics
8th Edition
ISBN:9781544336329
Author:Robert L. Sexton
Publisher:Robert L. Sexton
Chapter25: Money, Banking, And The Federal Reserve System
Section: Chapter Questions
Problem 24P
Question

Help me with [part A with the graph illustration. 

2. Escape from QE pre Covid19 Pandemic
Consider the US economy a few years ago, in particular before the Pandemic in 2020. An important
issue during that period was the possible scenarios and escape paths for the FED from quantitative
easing.
a. Because the economy was heating up, banks begin to reduce the ratio of reserves relative to
deposits (i.e. they lend out a larger fraction of their deposits.) Describe and illustrate how this
will affect (i) the money supply and (ii) aggregate demand (if at all).
b. Assuming no policy intervention, describe what happens to inflation and output in the short and
in the long run.
c. Suppose that the FEDs objective is to stabilize the price level at the level prior to the economy
heating up. Should it intervene in response to banks changing their lending decisions? How
could the FED intervene via open market operations?
d. In conjunction with open market operations, the FED decides to change the amount of interest
it pays on reserves. How would it want to change the interest rate it pays on reserves? How
would this affect banks' lending decisions?
Transcribed Image Text:2. Escape from QE pre Covid19 Pandemic Consider the US economy a few years ago, in particular before the Pandemic in 2020. An important issue during that period was the possible scenarios and escape paths for the FED from quantitative easing. a. Because the economy was heating up, banks begin to reduce the ratio of reserves relative to deposits (i.e. they lend out a larger fraction of their deposits.) Describe and illustrate how this will affect (i) the money supply and (ii) aggregate demand (if at all). b. Assuming no policy intervention, describe what happens to inflation and output in the short and in the long run. c. Suppose that the FEDs objective is to stabilize the price level at the level prior to the economy heating up. Should it intervene in response to banks changing their lending decisions? How could the FED intervene via open market operations? d. In conjunction with open market operations, the FED decides to change the amount of interest it pays on reserves. How would it want to change the interest rate it pays on reserves? How would this affect banks' lending decisions?
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