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The Federal Council of Elrond (Fed) controls the banking system in Middle Earth. The Council is responsible for controlling the money supply and implementing monetary policy.
a) The Council wishes to expand the money supply. Describe precisely how this would work through open market operations and effects on reserves.
b) The Council wishes to decrease the money supply. Describe precisely how this would work through the required reserve ratio and effects on reserves.
c) The Council wishes to decrease the money supply. Describe precisely how this would work through the discount rate and effects on reserves. If the money supply in Middle Earth is $10,000, velocity of money is a constant 3, the price level is 2.0, and output is constant at 15,000,
d) What is aggregate demand? What is nominal GDP? How did you get your answer?
e) The Council increases the money supply by $1,000. What is the net effect on the economy of the increase in the money supply in this case? Graph the impact on the Middle Earth economy with a constant level of real GDP and velocity (simple AD/AS model). Use actual numbers. I’ll do in class
f) Explain exactly and draw how the change in e) affects the money market in the short run. What are the dynamics that make the nominal interest rate adjust in the long run? (don’t use numbers—answer in general terms)
g) Now suppose that the Council implements a technological innovation with ATM’s in Middle Earth. Graph the change in the money market and explain how the change comes about. (don’t use numbers—answer in general terms)
 
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