Money and inflation

1. Indicate whether the following statement is true, false, or uncertain and explain your answer using words graphs and equations as appropriate.

1. If the commercial banking system does not gold any reserves, then it cannot affect the money supply.
2. If consumption depends positively on the level of real balances and real balances depend negatively on the nominal interest rate in a neoclassical model then the nominal interest rate rises 1% for each 1% rise in the money growth rate.
3. If only unanticipated changes in the money supply affect real GDP, the public has rational expectations and everyone has the same information about the state of the economy, then a policy of keeping the money supply constant is optimal

2. Consider a classical economy where the monetary base is 50000. Suppose people hold a quarter of their money as currency and the rest as bank deposits. Banks hold a quarter of their deposits as excess reserves, and the required reserve ratio is 0.25

1. Derive the reserve-deposit ratio the reserve-deposit ratio, the currency-deposit ratio, the money multiplier, and the money supply
2. If people now decide to one third half of their money as currency, what happens to the money supply? What would the central bank need to do to keep the money supply the same as in part (i)?

Now consider a Keynesian Economy

3. Briefly explain the Keynesian derivation of the money demand equation, if there is a sudden decrease in the income, what happens to equilibrium in the money market?
4. Now suppose that based on empirical data during Covid. It is determined that money demand does not depends upon peoples income. In this case briefly explain how we derive the LM curve from the money market. Illustrate and briefly explain the impact of expansionary monetary policy in an IS-LM context