1. (20 points) The country of Iceland has only one commercial bank and a central bank. In Iceland all financial transactions occur within the banking system: no one holds currency. The required reserve ratio imposed by the central bank is 10% of deposits. All amounts are in Iceland Krona.

a. (4 points) Provide a T-account for both the commercial bank and the central bank showing how they look like when the commercial bank holds only the minimum reserves required.

b. (2 points) Why would the bank not voluntarily hold more reserves?

c. (4 points) Suppose the central bank of Iceland purchases 5,000 Krona worth of treasury bills from the commercial bank. Provide a T-account for the commercial bank once the commercial bank lends out its excess reserves after the final round of the money multiplier process.

d. (4 points) If the central bank wanted to purchase the treasury bills in order to do expansionary monetary policy, what determines the effectiveness of this monetary policy? Explain your answer.

e. (6 points) Show in the appropriate graphs the short- and long-run effects of this monetary policy on output and prices.

1. (20 points) The country of Iceland has only one commercial bank and a central bank. In Iceland all financial transactions occur within the banking system: no one holds currency. The required reserve ratio imposed by the central bank is 10% of deposits. All amounts are in Iceland Krona. Central Bank of Iceland Commercial Bank Assets Liabilities Assets Liabilities Treasury bills 15,000 Reserves 15,000 Required reserves 15,000 Deposits 100,000 Loans 85,000 Capital 20,000 Treasury bills 20,000 Total 15,000 15,000 Total 120,000 120,000 a. (4 points) Provide a T-account for both the commercial bank and the central bank showing how they look like when the commercial bank holds only the minimum reserves required. b. (2 points) Why would the bank not voluntarily hold more reserves? c. (4 points) Suppose the central bank of Iceland purchases 5,000 Krona worth of treasury bills from the commercial bank. Provide a T- account for the commercial bank once the commercial bank lends out its excess reserves after the final round of the money multiplier process. d. (4 points) If the central bank wanted to purchase the treasury bills in order to do expansionary monetary policy, what determines the effectiveness of this monetary policy? Explain your answer. e. (6 points) Show in the appropriate graphs the short- and long-run effects of this monetary policy on output and prices