1. a. In the graph below show the Bond Supply-Demand model in equilibrium at price = $1000 and an interest rate of 12%, at a quantity of $100,000. Be sure to label all three axes, the curves, and the point of equilibrium (A). [4 points] b. Assume that the current market price is $900. At this price is there an excess supply or excess demand for bonds? At this price is there an excess supply or excess demand for money (hint: think of the liquidity preference framework)? Will bond vields go up or down if the excess supply/demand is resolved, and the market moves back to equilibrium? [4 points]c. Assume that the economy enters a boom period. Explain how the economic expansion affects bond demand and bond supply. Now show in the (original) graph above how the recession affects the bond market. Label the new equilibrium (B), the new quantity (Q1), the new price (P,), and the new equilibrium interest rate (i,). [4 points] d. Now explain how the impact of the expansion on the interest rate would change if the Federal Government responded to the strong economy by decreasing spending and its budget deficit. (Showing the change graphically is not necessary, but feel free to draw a graph if it helps you think through the answer.) [4 points]2. In the following, assume that the required reserve ratio is 10%. a. With T-Accounts (like the ones below), show the immediate effect of a $5000 Open Market Purchase by the Fed from a member of the public who deposits the Fed's payment into a checking account at the AAA Bank. [4 points] AAA Bank Fed Assets Liabilities Assets Liabilities b. What is the immediate effect (before the banking system has fully adjusted) of the Fed's bond purchase in part (a) on the monetary base? On the money supply? [4 points] c. What is the long-run effect (after the banking system has fully adjusted) of the Fed's bond purchase in part (a) on the money supply? Assume that the non-bank public holds no physical currency and banks hold no excess reserves. [4 points]3. a. Show graphically the effect of an o]:- market purchase in the market for reserves If federal funds market} when the relevant portion of the demand curve is the downward sloping portion. What is the effect on the federal funds rate? [4 points] b. Show graphically the effect of an o]:- market purchase in the market for reserves {federal JJIdS market] when the relevant portion of the demand curve is the horizontal portion. What is the effect on the federal funds rate? [4 points] 4. a. Write out the Taylor Rule and define all variables in your expression. [4 points] b. Assume the Fed sets both the equilibrium real federal funds rate to 3% and the inflation target to 2%. The current rate of inflation is 1% and Real GDP is 2% below potential GDP. Calculate the FOMC's federal fund rate target if it follows the Taylor rule. [4 points] c. Calculate the new Taylor rule federal funds rate target if the current rate of inflation increases from 1% to 3% (all else stays constant). [4 points]
