Part I. Answer the following questions.
1. Assuming the banking system is operating with a reserve to deposit ratio (p = 0.05), and a cash-to-
deposit ratio (x = 1.0), estimate the money multiplier. With an amount of outstanding currency of $1
trillion, calculate the values of $M_0$ and $M_1$.
2. Assuming nominal GDP is $15 trillion, calculate the current velocity of money with respect to $M_1$.
3. Use the Classical Economic interpretation of the quantity theory of money, and the money multi-
plier equation to predict what would happen if the central bank decided to purchase $100 billion in
government bonds from the general public. Calculate the percentage change in prices as a result of
this change. For just this part of the question, assume that the money multiplier, transactions, and
velocities are fired.
4. If instead, banks chose to not make any new loans as a result of this action, what would be the new
values of the multiplier, velocity, and prices? Briefly explain.