Essentials of Economics 7th Edition by Gregory Mankiw

Exercise 18

In the early 1980s, new legislation allowed banks to pay interest on checking deposits, which they could not do previously.
a. If we define money to include checking deposits, what effect did this legislation have on money demand? Explain.
b. If the Federal Reserve had maintained a constant money supply in the face of this change, what would have happened to the interest rate? What would have happened to aggregate demand and aggregate output?
c. If the Federal Reserve had maintained a constant market interest rate (the interest rate on nonmonetary assets) in the face of this change, what change in the money supply would have been necessary? What would have happened to aggregate demand and aggregate output?