Hi please help me with this exam revision question for macroeconomics , I do not have the model answer for it and it would be of much help if you can help me with it. Thank you so much!!
10. The demand for money is M"/P = L(Y, i), where L(Y, i) is an increasing function of real income Y. For i > 0, money demand is decreasing in the nominal interest rate i. Money demand becomes perfectly interest elastic at i = 0. The price level is P. (a) [2 marks] Give a brief justification of each of the properties of the money demand function assumed above. The LM curve represents money market equilibrium (M = M:). Assume the cen- tral bank targets a constant money supply M and that the price level P is fixed. (b) [3 marks] Show how the LM curve is derived from money-market equilibrium. Illustrate the LM curve, taking account of its shape where i = 0. Suppose that owing to lighter lending criteria, firms' investment demand is lower (treat this as affecting the autonomous component of investment demand). (c) [3 marks] Using the IS-LM model, show how this can result in the interest rate i falling to zero. If that happens, explain why the model predicts the economy enters a liquidity trap where conventional monetary policy is ineffective. Now consider the AD-AS model where nominal wages are fixed in the short run at a level where labour demand is less than desired labour supply. (d) [3 marks] Explain how the shape of the AD curve is affected by the liquidity trap. Following the negative shock to investment demand, can lower prices P mitigate the fall in real GDP found in part (c)? The Fisher equation that links the real interest rate r to the nominal interest rate i and expected future inflation nisi = r+ me. (e) [3 marks] Analyse the effects of higher inflation expectations w using the IS-LM model and deduce the impact on the AD curve. In August 2020, the Federal Reserve Board announced that it would now pursue a policy of average inflation targeting. This means where current inflation under- shoots its target value, the Fed would aim for a higher rate of future inflation to make up for it. Assuming this policy is credible, suppose that inflation expecta- tions * adjust so that (# + #*)/2 remains constant. (f) [4 marks] How would adopting the average inflation targeting policy affect the shape of the AD curve? Would it lead to a better outcome for real GDP following the shock to investment demand compared to part (d)? Explain. (g) [2 marks] According to the AD-AS model, if the economy remains in a liquidity trap in the future, would the Fed be able to ensure the average inflation target is met? What are the implications for the credibility of this policy