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Let be the following model, a modified version of the model in question 2: yt = C+ + gr ydt = ye + 1-1bhi-1 -

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Let be the following model, a modified version of the model in question 2: yt = C+ + gr ydt = ye + 1-1bhi-1 - to to = 0( )+ + [1 1bat- 1) VI = Vi- 1 + yd - C C = 1 . ydt + 02 . VI-1 hhit = Vt - bhit (28) A1 but = by,t-1 + (gr + /t-1bs,t-1) - (to + 1-1bcb,t-1) (29) hs,t = bcb,t (30) but = bat - beb,t (31) In this model, the redundant equation is h, = /. We assume that the central bank holds a fixed amount of government bonds Bcb,r = 49. 61411 and that the government spends gr = 50 at all periods. Let us postulate, as before, that 0 = 0. 2, a, = 0. 6, a. = 0. 4, Ao = 0. 635, A, = 5 and 1, = 0. 01. ga) Intuitively explain why, in this model, it can be said that the central bank conducts monetary policy by controlling the amount of money in circulation rather than controlling the interest rate on treasury bonds? 3b) Intuitively explain why, in this model, household demand for treasury bills is given by the equation but = but - Debt while our usual application equation for treasury bills has been written DM - do + 12 YO3c) What is the level of GDP yr, consumption, debt-to-GDP ratio and steady-state interest rate? Also identify the proportion of public debt held by the central bank in a steady state. Let us now assume that the central bank wants to slow down economic activity by reducing the amount of money in circulation by 10%. 3d) How will the central bank manage to reduce the amount of money in circulation by 10%? The answer to this question will tell you what shock to use to simulate the economic impacts of such a policy

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