(a) We learnt that the interest rate affects both the prices of bonds and the demand for money. Explain each of these relationships. Do these relationships hold when interest rates are negative? Why do you think central banks would choose to lower interest rates in their economies in the negative domain?

(b)Suppose that the household nominal income in an economy is 5,000 billion and the demand for money is given by

Md=Y(0.080.4i)

1. If the money demand is equal to 100 billion what is the interest rate?
2. What should the central bank do to interest rates if it wants to increase the money supply to 300 billion?
3. If the central bank decides to expand money supply to 300 billion, should it change the interest rate or implement open market operations?