Download Homework #5, Due Tuesday, Nov 14

Homework #5, Due Tuesday, Nov 14.
1) Monetary policy has several tools and the one used more frequently is
A) open market operations.
B) changing the discount rate.
C) changing required reserve ratios.
D) changing borrowing at commercial banks.
Answer: A
2)
A)
B)
C)
D)
Fed increased the discount rate from 6.25 percent to 6.5 percent on August 17, 2006. This increase
means that
the Fed has used open market operations.
the Fed has conducted fiscal policy.
the Fed is trying to change the amount of money in circulation.
the required reserve ratio will increase as well.
Answer: C
3) Which of the following increases the quantity of money?
A) an individual’s cash withdrawal from a bank.
B) an individual’s purchase of a bond from the Fed.
C) a decrease in the required reserve ratio.
D) an increase in the required reserve ratio.
Answer: C
4)
A)
B)
C)
D)
You deposit $4,000 in currency in your checking account. The bank holds 20 percent of all deposits as
reserves. As a direct result of your deposit, your bank will create
$200 of new money.
$800 of new money.
$1,600 of new money.
$3,200 of new money.
Answer: D
5)
A)
B)
C)
D)
You withdraw $2,000 from your account. Your bank has a desired reserve ratio of 20 percent. This
transaction, by itself, will directly reduce
the quantity of money by $1,600.
deposits by $1,600.
the quantity of money by $2,000.
deposits by $2,000.
Answer: D
6) The opportunity cost of holding money is the
A) interest rate.
B) price of goods and services.
C) level of wage and rental income.
D) ease with which an asset can become money.
Answer: A
7) If bond prices fall,
A) interest rates rise.
B) interest rates fall.
C) bank reserves grow.
D) households increase cash holdings.
Answer: A
8) Which of the following actions raise the interest rate?
A) A decrease in the demand for money.
B) An increase in bond prices.
C) An increase in the quantity of money.
D) An increase in the demand for money.
Answer: D
9) If the Fed carries out an open market operation and buys U.S. government securities, the interest rate
A) falls and the quantity of money increases.
B) rises and the quantity of money increases.
C) falls and the quantity of money decreases.
D) rises and the quantity of money decreases.
Answer: A
10) In the quantity theory of money, the velocity of circulation is assumed to
A) be not influenced by the quantity of money.
B) rise during recessions.
C) fall during recessions.
D) be unrelated to the equation of exchange.
Answer: A
11) The quantity theory of money predicts how changes in
A) the price level affect nominal GDP.
B) the price level affect real GDP.
C) the quantity of money affect the price level.
D) real GDP affect the nominal GDP.
Answer: C
12) Which of the following causes a leftward shift in the demand for money curve?
A) increased use of credit cards.
B) increased use of automatic teller machines.
C) increase in interest rates.
D) Both answers A and B are correct.
Answer: D
13) Which of the following decreases the demand for money?
A) An increase in the price level.
B) An increase in M1.
C) A decrease in real GDP.
D) A decrease in the cost of printing money.
Answer: C
14) Suppose that the price of a bond last week was $950 but this week its price is $975. Between last
week and this week interest rates
A) have fallen.
B) have stayed about the same if inflation is roughly the same.
C) have risen.
D) are unaffected by bond prices.
Answer: A
15) Suppose the money market has an equilibrium interest rate of 10 percent. If the actual interest was 8
percent, the quantity of money demanded would be greater than the quantity of money supplied.
Which of the following would bring the money market back to equilibrium?
A) People buy bonds, the price of bonds rises and the interest rate rises.
B) People buy bonds, the price of bonds falls and the interest rate rises.
C) People sell bonds, the price of bonds rises and the interest rate rises.
D) People sell bonds, the price of bonds falls and the interest rate rises.
Answer: D
16) Suppose the money market is in equilibrium and then the economy experiences a recession so that real
GDP decreases. The quantity of money does not change. What effect will the recession have on
equilibrium interest rates?
A) interest rates rise
B) interest rates fall
C) interest rates do not change
D) there is not enough information to tell what happens to interest rates
Answer: B
17) If the Fed wants to raise interest rates it will
A) buy bonds in order to increase the quantity of money.
B) sell bonds in order to decrease the quantity of money.
C) buy bonds in order to decrease the quantity of money.
D) sell bonds in order to increase the quantity of money.
Answer: B
18) If the aggregate demand curve shifts rightward following an increase in the quantity of money, what
can be concluded if the short-run aggregate supply curve is rather steep?
A) There will be a significant increase in real GDP with little impact on the price level.
B) There will be a significant increase in both real GDP and the price level.
C) There will be little increase in real GDP but a significant increase in the price level.
D) There is significant unemployment and slack in the economy.
Answer: C
19) If nominal GDP = $10 trillion and the quantity of money is $2 trillion, what is velocity?
A) 16
B) 8
C) 5
D) 2
Answer: C
20) The U.S. historical evidence
A) supports the quantity theory of money in the long run.
B) does not support the quantity theory of money.
C) demonstrates that there is no correlation between the money growth rate and inflation.
D) shows that a higher inflation rate causes an increase in the money growth rate.
Answer: A
21) Which of the following is true regarding the quantity theory of money?
I.
The theory predicts that in the long run the inflation rate equals the money growth rate minus the
growth rate of potential GDP.
II. The theory predicts that countries with high growth rates of money will have high inflation rates.
III. The long-run U.S. relationship between money growth and inflation supports the theory.
A) I and II.
B) II and III.
C) I and III.
D) I, II and III.
Answer: D
22) According to the quantity theory of money, changes in the price level are usually the result of changes
in the
A) prime interest rate.
B) real interest rate.
C) quantity of money.
D) velocity of circulation.
Answer: C
23) If the currency to deposit ratio is 0.25, and the required reserve ratio is 0.1. If a bank sold $100,000 to
the Fed. Immediately, how much additional money that the bank can use as loans?
A) $40,000
B) $60,000
C) $72,000
D) $67,000
Answer: C
24) Which of the following is NOT a short-run effect of an increase in the quantity of money?
A) People try to buy more goods and services.
B) Banks have excess reserves.
C) Aggregate supply increases.
D) Price level increases.
Answer: C
25) A decrease in the quantity of money
A) increases interest rates, investment, and aggregate demand.
B) raises the interest rate, decreases investment, and decreases aggregate demand.
C) lowers the interest rate, increases investment, and increases aggregate demand.
D) decreases the interest rate, investment, and aggregate demand.
Answer: B
Essay Questions:
1. (10 points) According to the book, the reserve ratio in the US r = 0.08, and the
currency to deposits ratio c = 1.06.
Suppose Fed buys $100,000 of securities from banks; banks loan this amount to
an investors. How much additional deposits that the bank would have? With this
additional deposit, how much would have to be used as a reserve, and as a loan?
In total, how much additional money created in the market?
If the reserve ratio is now changed to .15. How much additional money that Fed
creates by purchasing $100,000 bond from the bank?
Solutions:
It is better to answer this question in steps.
Step 0: $100,000 loan, in which $100,000/(1+c) = D0 = $100,000/2.06 = $48,544.
Step 1: The bank now has D0= $48,544 additional deposit. The bank is going to divide
the money into two parts, reserve and loan. The amount of reserve from D0 is: R1 = r D0 =
0.08*$48,544 = $3,884, the amount of loan is: L1 = (1-r) D0 = 0.92 * $48,544 = $44,660.
Step 2: At the loan amount of L1 = $44,660, part of loan will be in currency, and part of
them will in deposit. The amount of deposit is given by: D1=L1/(1+c) = (1-r) D0 / (1+c)
Repeat this process. In general, Dk = [(1-r)/(1+c)]k D0
Therefore, the total amount of deposit in the bank is:
D = D0 + D1 + D2 + D3 + L
⎡ 1− r ⎛1− r ⎞ ⎛1− r ⎞
⎤
= D0 ⎢1 +
+⎜
⎟+⎜
⎟ + L⎥
⎣ 1+ c ⎝1+ c ⎠ ⎝1+ c ⎠
⎦
D0
D (1 + c )
=
= 0
1− r
c+r
1−
1+ c
$48,544(1 + 1.06)
=
= $87,720
1.06 + 0.08
Total Reserve: R = r D = $7,018
Total loan amount is: (1- r) D + $100,000 = $180,703
Monetary base is given by: B = (r + c) D = D0 (1+r) = $100,000
Total amount of money is created by: M = (1+c) D = 2.06 * $87,720 = $180,703
If r = .15, then:
Total amount of deposit: $100,000/(c+r) = $100,000/(1.06 + 0.15) = $82,645
Total amount of money created: M = (1 + c) D = $170,249
Total mount of loan: (1 – r) D + $100,000 = $170,249
2. (15 points) #10 on page 276
a. Failures of banks reduce amount of deposits, and hence reduce quantity of
money.
b. Reducing quantity of money would shift aggregate demand curve left.
Total aggregate demand is lower.
c. In the short run, if the supply curve is not completely vertical, then bank
failures would reduce GDP, and the price level in general would be lower.
d. Over the long run, the real GDP is going to come back to its potential
output level. Lower price is expected.