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Answers to Questions #1 & #2
a) 100% r.r.
b) 10% r.r.
First Generation Bank
Assets
Required
$5,000
Reserves
Liabilities
$5,000 Demand
Deposits
----------------------------------------------Total
$5,000
i)
MS ↑ $5,000
ii)
iii)
$5,000
$5,000
First Generation Bank
$5,000
(Fed has “new” money)
Assets
Required $500
Reserves
Excess
Reserves
Liabilities
$5,000 Demand
Deposits
$4,500
-----------------------------------------------
Total
$5,000
i)
$4,500
ii)
iii)
iv)
MS ↑ $50,000
$5,000
$50,000
$5,000
($4,500 X 10 + 5K)
(c)
If banks keep some of the deposit as excess reserves, how will this influence the
change in the money supply that was determined in part (b)(ii)? Explain.
If the banks hold some of the excess reserves => increase in the money supply
would be less than $50,000 => banks lend less money => less money creation
========================================
d) When the Federal Reserve purchases bonds in the open market
what happens to the price of bonds?
The price of bonds would rise. When bond prices ↑ => interest rate ↓
(inverse relationship)
a) One point for a correctly labeled graph of the short-run Phillips curve (SRPC).
• One point for showing a vertical long-run Phillips curve (LRPC) and the
point A to the right of the LRPC on the SRPC.
B) U.S. economy in a recession
C) Gov’t raises taxes => AD shifts left => real GDP falls => bigger recession
Question d
ii)
MS1 MS2
Nominal
Interest
Rate
i1 ---------
i) Buying Bonds in Open Market Operations injects
money into the banking system increasing money
supply and lowering nominal interest rates
(federal funds rate)
i --------------2
MD
Q1
Qty of $
iii) Lower interest rates => more Investment (I) & Consumption (C)
=>
AD will shift right => real GDP ↑ & Price Level ↑
iv) Monetarists believe money is neutral => an increase in MS
Will have no effect on real GDP. Only nominal GDP would rise
Question e
i)
SRAS shifts right as the expected price level falls
ii) The natural rate of unemployment is unchanged.