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Unformatted text preview: ECON 420-002 and 004 Homework 4 Due in class on Oct. 22, 2008 1. Suppose that a change in government regulations allows banks to start paying interest on checking accounts. Recall that the money stock is the sum of currency and demand deposits, including checking accounts, so this regulatory change makes holding money more attractive. Use the AD-AS model to answer the following questions. a. How does this change affect the demand for money? Demand for money will rise. b. What happens to the velocity of money? Velocity of money will fall. c. If the Fed keeps the money supply constant, how will the AD curve will affected? What will happen to output and prices in the short run and in the long run? AD curve will shift to the left. In the short run, with prices fixed, there will be no change in it. The economy will move from point A to point B and output will fall to Y . In the long run, when prices adjust fully to this fall in AD, output will return to potential GDP while price level will fall to P 1. The new equilibrium will be at point C. LRAS P P B A SRAS P 1 C AD 1 AD Y Y d. Should the Fed keep the money supply constant in response to this regulatory change? Why or why not? The Fed can offset this decrease in AD by pursuing an expansionary monetary policy if the Fed can accurately measure the change in velocity. Since the fall in AD was caused the Fed can accurately measure the change in velocity....
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This document was uploaded on 10/28/2011 for the course ECON 420 at UNC.
- Fall '08