Assume a reserve requirement ratio of 10 percent and no excess reserves in banking system to start with. Suppose that the Central Bank conducts an open market operation in which it purchases 5000 TL worth of Treasury Bills from the commercial banks. Monetary base is the same; but commercial banks stop lending (credit crunch).

a. Suppose that during the year government has given budget surpluses and used this surplus to buy back some

of the outstanding Treasury Bills from the public, reducing the debt. What is the influence of this operation on the money supply? Explain by referring to the difference between Central Banks open market operations of buying

Treasury Bills and governments purchases (buying back) of Treasury Bills using the surplus in budget.

b. How would the money supply change? Explain by referring to the role of commercial banks in the money

creation process.

c. Use well labeled money demand and money supply curves and explain the effects of the credit crunch on

the interest rates. What is the mechanism that changes interest rates?

d. What would be the effect of this interest rate change on the components of AD?

e. Use AD & AS analysis to show the SR and LR effects of the credit crunch on the p-level and output of the

economy. Explain your work.