Assume that the banking sector is described as follows: D=d0 –d1 (i–iD) L=l0 –l1 (i–iL ) Where L stands for bank loans, D stands for bank deposits, iL the loan rate, iD deposit rate and i is the market interest rate. Assume that banks do not have operating costs or are not required to hold reserves. (a) Calculate the competitive equilibrium in a diagram. How do your results change when the government sets deposit rates equal to iD = a with a < iL . Provide intuition. (b) Now suppose that government introduces a mandatory reserve ratio r* such that R = r*D. How do your results change? What are the implications of such a reserve ratio policy on prices and quantities? Provide intuition. (c) Sometimes, it is suggested that the reserve ratio policy can be alternative to targeting interest rates or monetary aggregates. Can this be an effective policy to stabilize output and inflation fluctuations?
Assume that the banking sector is described as follows: D=d0 –d1 (i–iD) L=l0 –l1 (i–iL ) Where L stands for bank loans, D stands for bank deposits, iL the loan rate, iD deposit rate and i is the market interest rate. Assume that banks do not have operating costs or are not required to hold reserves. (a) Calculate the competitive equilibrium in a diagram. How do your results change when the government sets deposit rates equal to iD = a with a < iL . Provide intuition. (b) Now suppose that government introduces a mandatory reserve ratio r* such that R = r*D. How do your results change? What are the implications of such a reserve ratio policy on prices and quantities? Provide intuition. (c) Sometimes, it is suggested that the reserve ratio policy can be alternative to targeting interest rates or monetary aggregates. Can this be an effective policy to stabilize output and inflation fluctuations?
Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Assume that the banking sector is described as follows: D=d0 –d1 (i–iD) L=l0 –l1 (i–iL ) Where L stands for bank loans, D stands for bank deposits, iL the loan rate, iD deposit rate and i is the market interest rate. Assume that banks do not have operating costs or are not required to hold reserves. (a) Calculate the competitive equilibrium in a diagram. How do your results change when the government sets deposit rates equal to iD = a with a < iL . Provide intuition. (b) Now suppose that government introduces a mandatory reserve ratio r* such that R = r*D. How do your results change? What are the implications of such a reserve ratio policy on prices and quantities? Provide intuition. (c) Sometimes, it is suggested that the reserve ratio policy can be alternative to targeting interest rates or monetary aggregates. Can this be an effective policy to stabilize output and inflation fluctuations?
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