Money and banking

Part A
A. 1. Review
Investors in Lindonesia have three investment options: saving in banks, government bonds and stocks.
Following an economic recession, government has decided to boost the economy by reducing the
overnight rate. Answer the following questions, using the appropriate model. Provide an illustration if
applicable.
1. What is the consequence of Lindonesian government’s policy for the bonds market?
2. Explain the consequence of Lindonesian government’s policy for nominal interest-rates, immediately
and later-on, assuming no inflationary bias.
3. What is the impact of this policy on the stock market in Lindonesia?
A. 2. Money Supply Process
The currency in circulation in Cyperussia is 50 billion Cyper dollars (Cp$). The Cyperussian Central bank
sets the required reserve ratio at 5% for the year 2015. Cyperussian citizens have 250 billion Cyper
dollars in their chequable deposit accounts. Answer the following questions.

s _ 1+_C _ 11
Hlnt. Use the formula. M – MB (He) – (R + C) (He)
1. What is the Money Supply, M 5, in Cyperussia?
2. What is the currency ratio, C, in Cyperussia?
3. What is the Money Multiplier in Cyperussia?
4. In February 2015, the Cyperussian Central Bank deposits 300 million Cyper dollars in the country’s
banking system reserves. What is the impact on Money Supply, in Cyperussia?
5. In March 2015, the Cyperussian Central Bank changes the required reserve ratio to 4.5%. What is the
impact of this change on Money Supply, in Cyperussia?

Part B

The Central Bank of Lindonesia conducts its monetary policy through Last Resort Lending. In March
2015, it reduced the Target Overnight Interest Rate, i3}, from 1.25% to 1%. The volume of NBR in
Lindonesia is 3 billion Lindon dollars.

Answer the following questions.

1. What kind of policy is it? Give an example for an economic reason that justifies this monetary policy.
3. Use the model to explain the impact of this policy on the Banking System in Lindonesia.

4. Use the appropriate Model (with illustration) to analyze the impact of this policy on the Nominal
Interest-rates.

4. Use the appropriate Model (with illustration) to analyze the impact of this policy on the yield of Bonds.
6. Use the appropriate Model to analyze the impact of this policy on the price of Stocks.

7. What will be the impact of this policy on real sector (inflation, unemployment, and GDP)?

8. Use the appropriate model to analyze the impact of this policy on Foreign Exchange Market, using
USD as the foreign currency.

Part C

(i)

The economists of the Central Bank of Litzenbourg found that in the first quarter of 2015, the country’s
output growth has been 2% instead the forecasted 3% level. And, the inflation rate has lagged behind its
target by 1%. In this country, we have that 01y = an = Use the Taylor Rule to calculate the required
change in igR.

(ii)

In Lindonesia, the output growth is above its forecast by 1% while the inflation rate is 4% instead of its
target level of 2%. If we have that 01y = an = %, what is the required change in igR, according to the
Taylor Rule?

Hint: AigR = ay(yt – y*) + «Hart – 11*)