An economy begins in long

-run equilibrium and then a change in government regulations

allows banks to start paying interest on chequ

ing accounts. Recall that the money stock is the

sum of currency in circulation and demand deposits, including chequing accounts, so this

regulatory change makes holding money more attractive.

a.

How does this change affect the demand for money?

b.

If the central bank keeps the money supply constant, what will happen to output and

prices in the short run?

c.

If the goal of the central bank is to stabilize the price level, should the central bank keep the money supply constant in response to this regulatory change? If not, what should it do?

Why