Money demand, money supply and interest rate determination: Practice Questions

When the nominal interest rate in the economy increases, the opportunity cost of holding money will ________ and the quantity of money demanded for asset purposes will ________.

Suppose the volatility of the stock market increases significantly, causing the public to shift their wealth from stocks to safer assets like money. If the central bank maintains a constant money supply, what will be the effect on the equilibrium nominal interest rate and bond prices?

During an economic recovery, the real income of the public increases. Simultaneously, the central bank conducts open market sales of government bonds. Which of the following must occur to the equilibrium nominal interest rate (\( r \)) and the quantity of money held for asset purposes?

In a competitive money market, when the demand for money is less than the money supply at the current nominal interest rate, the market interest rate will ________, which eventually leads to ________ in the quantity of money demanded.

Suppose commercial banks introduce automatic overdraft protection for all checking accounts, which effectively allows customers to hold smaller precautionary cash balances for unforeseen expenses. If the central bank keeps the money supply constant, what will be the effect on the equilibrium nominal interest rate and the equilibrium quantity of money in the economy?

Briefly explain why an increase in real income leads to an increase in the demand for money for transactions purposes.

The central bank conducts an open market purchase of government bonds from the public. If commercial banks decide to hold the entirety of the newly received deposits as excess reserves instead of lending them out, explain the resulting effect on the monetary base and the money supply.

In the money market, the real income of the public increases significantly while the central bank simultaneously raises the required reserve ratio. Using a diagram, explain why the equilibrium nominal interest rate must increase, and describe the resulting change in bond prices.

(a) Briefly explain the two main motives for individuals to hold money according to the liquidity preference theory.
(b) Suppose the nominal interest rate in the economy increases. Explain how this change affects the opportunity cost of holding money and the quantity of money demanded for asset purposes.

Assume a simplified commercial banking system where commercial banks hold no excess reserves and the public's cash-deposit ratio is zero. The required reserve ratio set by the central bank is 10%.

(a) With reference to the concept of credit creation, explain what determines the maximum banking multiplier in this scenario. Calculate its value.

(b) Suppose, due to concerns about the stability of the banking system, the public suddenly decides to hold 20% of their money as cash, while commercial banks still hold no excess reserves. Assuming the monetary base remains unchanged, explain how this change in public behaviour affects the actual money supply in the economy.