Consider the Neo-Keynesian model of money and banking. Suppose that the demand for money function was MD = 4 Y - 1 000 i where MD is the quantity of money demanded, i is the rate of interest (an interest of 5 means 5 percent in this problem), and Y is real national income which currently is 1 500. The supply of money is 1 000, the target reserve ratio is 10 percent, there is no cash drain in the banking system, and the recessionary gap is 250. The price level does not change in this problem.Suppose the Bank of Canada reduces the target for the overnight rate prompting commercial banks to reduce the market rate of interest to 4 percent. Are the commercial banks experiencing now a situation of excess cash reserves or of too little cash reserves? What is the size of this excess/insufficient cash reserves when Y = 1 500?What will the commercial banks do to eliminate this excess/insufficient cash reserves? By how much should the level of cash reserves of the banking system change for the economy to move to full employment?

The Neo-Keynesian economic model emphasizes monetary policy's critical role in maintaining economic…

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ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Consider the Neo-Keynesian model of money and banking. Suppose that the demand for money function was MD = 4 Y - 1 000 i where MD is the quantity of money demanded, i is the rate of interest (an interest of 5 means 5 percent in this problem), and Y is real national income which currently is 1 500. The supply of money is 1 000, the target reserve ratio is 10 percent, there is no cash drain in the banking system, and the recessionary gap is 250. The price level does not change in this problem.

Suppose the Bank of Canada reduces the target for the overnight rate prompting commercial banks to reduce the market rate of interest to 4 percent. Are the commercial banks experiencing now a situation of excess cash reserves or of too little cash reserves? What is the size of this excess/insufficient cash reserves when Y = 1 500?
What will the commercial banks do to eliminate this excess/insufficient cash reserves? By how much should the level of cash reserves of the banking system change for the economy to move to full employment?

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