An economy begins in long-run equilibrium, and than a change in government regulations allows banks to start paying interest on chequing accounts. Recall that the money stock is the sum of currency and demand deposits, including chequing accounts, so this regulatory change makes holding money more attractive.
How does this change affect the demand for money?
What happens to the velocity of money?
If the central bank keeps the money supply constant, what will happen to output and prices in the short run and in the long run?
If the goal of the central bank is to stabilize the price level, should the bank keep the money supply constant in response to this regulatory change? If not, what should it do? Why?
If the goal of the central bank is to stabilize output, how would your answer to part (d) change?
Suppose the Bank of Canada reduces the money supply by 5 percent.
What happens to the aggregate demand curve?
What happens to the level of output and the price level in the short run and in the long run?
According to Okun’s law, what happens to unemployment in the short run and in the long run? (Hint: Okun’s law is the relationship between output and unemployment discussed in Chapter 2.)
What happens to the real interest rate in the short run and in the long run? (Hint: Use the model of the real interest rate in Chapter 3 to see what happens when output changes.)
Let’s examine how the goals of the Bank of Canada influence its response to shocks. Suppose central bank A cares only about keeping the price level stable, and central bank B cares only about keeping output and employment at their natural rates. Explain how each central bank would respond to
An exogenous decrease in the velocity of money.
An exogenous increase in the price of oil.