2 Money Demand, Money Supply and Monetary Policy [40 Points] 1. Suppose the price level in the economy is P and the nominal money supply is MS. Real money demand L(Y, i) is a function of real income Y and nominal interest rate i. And the nominal money demand is as follows, Md/ P = L(Y, i) = Ym . im where 1 > my > 0 and mi > 0. Suppose further that the growth rate of nominal money supply #, inflation rate 7, income growth rate g, and the real interest rate r, are all constant over time. Derive the relation between 7, / and g, when the asset market is in equilibrium. 2. Considering the following statement. "Commercial banks attract deposits from households so that they can lend deposits to firms. In other words, loans are created based on the quantity of deposits. " Is it true or false? Explain your answer carefully. 3. Considering the following statement. "Federal funds rate is a market rate, and therefore it cannot be affected by the central bank. " Is it true or false? Explain your answer carefully. 4. Explain why the conventional monetary policies can not be effective if the economy is stuck in a liquid trap