Consider the central bank balance sheet for the country of Riqueza. Riqueza currently has 2,000 million escudos in its money supply, 1,200 million escudos of which is backed by domestic government bonds; the rest is backed by foreign exchange reserves. Assume that Riqueza maintains a fixed exchange rate of one escudo per dollar, the foreign interest rate remains unchanged, and money demand takes the usual form, M/P = L(i)Y. Assume prices are sticky. a. What is value of reserves, R, in Riqueza's balance sheet? Assets Amount Liabilities Amount Money supply, Reserves, R 2,000 M Domestic credit, 1,200 B b. What is Riqueza's backing ratio? Backing ratio: % c. Suppose that Riqueza's central bank sells 400 million escudos in government bonds. Fill in the blanks to show how this affects the central bank balance sheet. Assets Amount Reserves, R Liabilities Money supply, M Amount Domestic credit, B d. What is Riqueza's backing ratio now? Backing ratio: % e. Now, starting from this new position in c, suppose that there is an economic downturn in Riqueza, so that real income contracts by 10% and money demand in turn contracts by 10%. Fill in the blanks to show how this affects the central bank balance sheet. Assets Reserves, R Domestic credit, B Amount Liabilities Amount f. What is the new backing ratio? Backing ratio: Money supply, M % g. In general, as the backing ratio money demand. This makes it the central bank becomes better equipped to handle adverse shocks to for the central bank to defend its peg.