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Macroeconomics I Money and banking Apr, 25th, 2017 Problem 1 – Let’s define monetary aggregates (M0, M1,..) using assets mentioned below. What is the most important difference between them? a) b) c) d) e) f) g) h) Physical cash and coin issued by the central bank and used in the economy. Cash printed by the central bank, but held in the vault (as uncirculated money). Cash issued by the central bank and held by the commercial banks in their vaults (as reserves). Cash issued by the central bank, but held by it in its vault (as reserves of commercial banks). Demand deposits. (overnight, current deposits) Savings deposits. (deposits redeemable at notice up to 3-months) Time deposits. (long-term deposits, deposits with agreed maturity up to 2 years) Debt securities issued with maturity up to 2 years. Problem 2 (based on SB/WB) – We consider an economy with only one commercial bank. Commercial bank balance sheet is as follows (values are expressed in $M) Assets Liabilities Cash ratio Public cash Money holding stock (M1) Cash 10 Deposits 100 Loans 90 Equity 10 10% 10 110 Bonds 10 Assume that public has a fixed demand for cash. The central bank issues cash worth $10M and buys bonds from the commercial bank for it. a) Answer what would the bank do with this money, knowing that it doesn’t want to hold more than 10% of deposits in cash? What would the public do then? b) Calculate the new balance sheet? c) Derive the formula for the money multiplier, assuming that the public has a fixed ‘currency drain ratio’ (i.e. percentage of deposits held as cash). Problem 3 – We consider a country in which the circulated currency is worth $20bn. The commercial banks hold vault cash worth $10bn. The demand deposits are worth $80bn in total, while time deposits’ value equals $50bn. There are no other means of storing value. Calculate: a) Monetary base (high-powered money), b) Money supply (M1), c) Money supply (M3), d) Money multiplier (M3), e) Reserve ratio, f) Currency drain ratio. Problem 4 – The central bank had issued cash worth 100. When the money supply (M1) was measured, it turned out that it equals 300. The reserve rate for commercial banks is 1/6. Calculate currency drain ratio. Problem 5 (SB/WB) – Commercial banks hold reserves equal to 5% of the issued deposits. Banks’ customers hold cash worth as much as one quarter of their deposits’ value. The stock of high-powered money is $12M. a) Calculate the value of money multiplier, b) Calculate the stock of money (M3), c) How would the value of money multiplier and M3 change if the reserve ratio fell to 4%? d) And what would happen if the currency drain ratio increased to 30%? Adam Czerniak, Ph.D. Department of Economics II True/False 1. 2. 3. 4. 5. Money is anything that generally is accepted as a medium of exchange. Fiat money is money the government says is money. Only the required reserve ratio determines how much money the banking system can create. A decrease in the required reserve ratio increases the money supply. A sale of government securities to the public by the central bank will increase the money supply. Multiple Choice 1. Which of the following characteristics are necessary for an asset to function as money? a) Backed by a precious metal. b) Authorized as legal tender by the monetary authorities. c) Generally acceptable as a medium of exchange. d) Having value in future transactions. 2. The development of money as a medium of exchange has facilitated the expansion of trade because: a) b) c) d) holding money increases peopleʹs wealth. holding money increases peopleʹs income. money eliminates the ʺdouble coincidence of wantsʺ problem. money creates the “double coincidence of wants” problem. 3. You received an income tax rebate last year and decided to put this money in a saving account so that you could spend it this summer. This is an example of money serving as a(n): a) b) c) d) store of value. medium of exchange. unit of account. investment good. 4. The main disadvantage of using money as a store of value is that: a) b) c) d) money is not portable. it requires a double coincidence of wants. currency is intrinsically worthless. the value of money actually falls when the prices of goods and services rise. 5. Commercial banks create money through: a) b) c) d) printing treasury notes. making loans. facilitating borrowing from the Federal Reserve to the public. reducing risk in the economy. Adam Czerniak, Ph.D. Department of Economics II