Question 4 Money supply and the multiplier Consider an economy with a banking sector and money supply, M. money demand is given by = $Y{0.5- 1.5i) for i20, and = M otherwise $Y is $4trn. Suppose that people desire to hold 10% {c=0.1) of their money in currency and 90% in deposits. Also, suppose that banks hold 10% of all deposits as reserves {6=0.1). Given that the central bank desires to keep the interest rate at 1% {i=0.01): a) What will be the overall equilibrium money supply (M)? (1 mark) b) What should be the equilibrium supply of central bank money (H)? (1 mark) If the central bank decides to reduce the interest to 0%: c) What must happen to overall money (M)? Explain why. (1 mark) d) What must happen to central bank money (H)? Explain why. (1 mark) e) Calculate the money multiplier. Explain its meaning. (1 mark) During the Great Depression in the 19305, bank runs led to people taking their money out of banks, preferring to keep it in currency. Suppose this meant c rose to 90% (=0.9). d) How did this shift from deposits to cash affect the size of the money multiplier? Explain what this means. (2 marks) e) Suppose the interest rate is at 0, and cannot be negative. If the central bank increased central bank money H by 10% from the value you found in part d) above, what will happen to the money market equilibrium value for M? Explain why this situation is called the liquidity trap