Suppose you are the head of the central bank and your mandate is to maintain the price level at a constant rate. Explain what you would do to the money supply in response to each of the following events. Discuss for each case a policy change of

1. an increase/decrease of the reserve requirement; and

2. an increase/decrease in the monetary base. Assume that growth in real GDP affects the growth in real money demand equally - i.e., L L = Y Y - and that the economy is closed or a large open economy.

a) Real GDP increases once by 4 percent.

b) Real GDP declines once by 1 percent.

c) Real GDP is growing at 3 percent per year.

d) Government spending increases and affects real money demand by 3 percent. e) The expected rate of inflation, e , rises.