Micro Economy Essay

In: Other Topics

Submitted By killathrun
Words 951
Pages 4
Question 1
Provide short answers to the following: (a) Explain in detail the process whereby banks create money. 1. Banks have excess reserves 2. Banks lend excess reserves 3. The quantity of money increases. 4. New money is used to make payments. 5. Some of the new money remains on deposit. 6. Some of the new money is a currency drain 7. Desired reserves increase because deposits have increased 8. Excess reserves decrease. (b) What factors constrain the ability of banks to create money?
There are 3 factors constrain the ability of banks to create money: 1. The monetary base 2. Desired reserves 3. Desired currency holding

Question 2
Provide short answers to the following: (a) Explain how the money market determines the nominal interest rate.
The nominal interest rate on other assets minus the nominal interest rate on money is the opportunity cost of holding money. (b) Discuss in detail how an open market purchase of securities by the Reserve Bank impacts the money market in the short run.
Starting from a short-run equilibrium, if the Reserve Bank increases the quantity of money, people find themselves holding more money than the quantity demanded. With a surplus of money holding, people enter the loanable funds market and buy bonds. (c) Explain how the money market then moves back to equilibrium in the long run. What has happened to the interest rate and price level in the long run?
First, the nominal interest rate falls. The real interest rate falls too, as people try to get rid of their excess money holdings and buy bonds. With a lower real interest rate, people want to borrow and spend more. Firms want to borrow to invest and households want to borrow to invest in bigger homes or to buy more consumer goods. The increase in the demand for goods cannot be met by an increase in supply because…...

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