Suppose that a country has a local currency known as the dollar, its money suppl

Question

Suppose that a country has a local currency known as the dollar, its money supply is $1,500 million, and its domestic credit is equal to $1,000 million in the year 2015. The country maintains a fixed exchange rate, the central bank monetizes any government budget deficit, and prices are sticky.

Compute total reserves for the year 2015 in dollars.

a) The central bank’s reserves will be 0.

b) The central bank’s reserves will be - $500 million.

c) The central bank’s reserves will be $500 million.

d) There is not enough data to calculate the reserves.

Explanation / Answer

c) The central bank’s reserves will be $500 million

Reason

As the money supply is higher than the domestic credit, money will be there in the reserve after the credit is repaid. Thus, the balance will be 1500-1000=500 million dollar.

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