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Monetary Policy algebraic example
Suppose we are given the following information:

RGDP gap:
 $100

Initial Deposits:
$50

Initial Reserve Ratio:
25%

Money Demand =
1000
–
100i

Demand for Loanable Funds = 200
–
10i

MPC:
0.8
Suppose the Fed wants to do open market operations:
Suppose the Fed wants to buy government bonds valued at $50.
Let’s follow the steps from class:
First find initial conditions:
1.
Find the initial interest rate:
a.
Initial maximum money supply = Initial Deposits *
= $50 *
= $50 * 4
= $200
b.
Interest rate in money market:
Money Supply = Money Demand
$200 = 1000
–
100i
i = 8%
2.
Find the old level of loans in the loanable funds market
Demand for loanable funds = 200
–
10i
= 200
–
10*8
= 120
Then see what monetary policy does:
3.
Find the new level of money supply (remember, the Fed buys $50 of bonds!)
a.
Initial deposits are $50 + $50 = $100
b.
Maximum money supply = $100 *
= $400
4.
Find the new interest rate in the money market
a.
Money supply = money demand
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This note was uploaded on 04/06/2010 for the course ECON 1102 taught by Professor Someguy during the Spring '07 term at Minnesota.
 Spring '07
 someguy
 Macroeconomics, Monetary Policy

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