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The following is the balance sheet of a banking system.
(a) Initially the banks held $100 million excess reserves and the public held $100 million cash. Suppose the central bank buys $40 worth of government bonds from the public.
(i) Calculate the new monetary base. Show your workings. (2 marks)
(ii) Calculate the maximum possible change in money supply. Show your workings. (4 marks)
(iii) State TWO assumptions under which the actual change in money supply would equal the maximum possible change in money supply. (2 marks)
(b) Based on the quantity theory of money, predict the effect of an open market purchase of government bonds by the central bank on the price level. State the assumption(s) need to reach your conclusion. (4 marks)
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