Download QUESTIONS FOR DISCUSSION

QUESTIONS FOR DISCUSSION
1.
Why do banks want to maintain as little excess reserves as possible? Under what
circumstances might banks desire to hold excess reserves? (Hint: see Figure 14.3.)
Excess reserves represent unused lending power. The opportunity cost of excess
reserves can be high. Banks are in the business of making profits. They need to
put their reserves to work by loaning them out and earning interest. In some
cases, banks may be hesitant to make loans and therefore might want to hold
excess reserves if they expect a relatively high withdrawal rate from the bank.
2.
Why do people hold bonds rather than larger savings-account or checking-account
balances? Under what circumstances might they change their portfolios, moving their
funds out of bonds and into bank accounts?
Bonds have the advantage of offering possible capital appreciation as well as
interest payments. Neither savings nor checking accounts do that. A significant
depreciation in the selling price of bonds - occasioned by an increase in interest
rates - might cause bondholders to sell them and move their funds into bank
accounts.
3.
If the Federal Reserve banks mailed everyone a brand-new $100 bill, what would happen
to prices, output, and income? Illustrate with aggregate demand and supply curves.
The initial impact would be to increase aggregate demand. This could increase
prices or output or both, depending on the shape of the aggregate supply curve.
The possibilities are illustrated in Figure 14.6.
4.
How does an increase in the money supply get into the hands of consumers? What do
they do with it?
An increase in the money supply occurs when banks make loans. If the loans are
to consumers, then consumers are direct recipients of the increase in the money
supply. If these loans are used to finance business investment, then consumers
are indirect recipients of the increase in the money supply as total payrolls
increase and the household sector’s income and spending increases.
5.
Is a reduction in interest rates likely to affect spending on pizza? What kinds of
spending are sensitive to interest rate fluctuations?
Since consumers usually pay cash for pizza, a change in interest rates would not
directly affect spending on pizza. For the most part, interest rate changes only
directly affect spending on items that are purchased with borrowed money such
as houses, cars,, etc.
6.
If banks and credit card companies charged zero interest, would people spend
and invest more? What would inhibit business or consumer borrowing?
When consumers borrow money for consumption, their main concern is
the amount of the monthly payment. At zero interest, they could
increase consumption without increasing their monthly payment.
Businesses would, in a similar fashion, be able to increase investment
expenditures. As long as the rate return on capital is greater than the
interest rate, it is a viable investment, ceteris paribus.
Even though there would not be any interest on these loans, the principle
still needs to be re-paid. Consumer and business spending would be
inhibited by two by their available income.
7.
Which aggregate supply curve in Figure 14.6 does the Fed chairman fear the
most? Why?
The Fed chairman would fear the vertical AS curve in panel ‘b’ the most.
In an economy with a vertical AS curve, an change in AD will only affect
prices without changing the rate of real GDP. In such cases, all changes
in AD will either be inflationary or deflationary and will have no effect
on the level of output.
8.
Like all human institutions, the Fed makes occasional errors in altering the
money supply. Would a constant (fixed) rate of money-supply growth eliminate
errors?
Although some policy analysts call for a constant rate of money-supply
growth, according to the Keynesian perspective this will not eliminate
errors. We know that the economy is going to have its ups and downs as
it moves through the business cycle. When the economy needs to be
stimulated, then the money supply growth rage should be increased;
when it needs to be slowed down, the money supply growth rate should
be decreased. Having a constant rate of money supply growth
guarantees that it will not be the right rate all of the time.
9.
Congress sometimes demands more control of monetary policy. Is this a good
idea? Why is fiscal policy, but not monetary policy, entrusted to elected
politicians?
Giving congress control of the money supply would be a bad idea.
Monetary policy is an art of fine-tuning the economy. Because of
political pressures, congress has a tendency to: a) take a long time to
make decisions, and b) over-react to economic problems. In addition,
having fiscal and monetary policy controlled by different institutions is
another example of “checks and balances” that are prevalent in our
political system. There is the fear of having too much power rest with
any one institution.
Fiscal policy is usually used to resolve major economic problems and to
help resolve specific social issues. This social engineering is better left to
the politicians where the electoral process helps determine what specific
taxation and spending programs are enacted.
10.
Would you advocate monetary restraint or stimulus for today’s economy? Who
would disagree with you?
The answer to this question obviously depends on the current state of the
economy. If the economy is expanding near full employment, monetary
restraint is needed to help prevent the economy from experiencing
increased inflation. If the economy is contracting away from full
employment, then monetary stimulus is needed to prevent the economy
from going into a recession. In each of these situations, those who
believe in “fixed rules,” i.e., the money supply should be increased by a
constant (fixed) rate would disagree.