Download Week 7 Practice Quiz a

QUIZ 5: Macro – Spring 2009
Name:
______________________
Section Registered (circle one)
T/Th 8:30-10:00 T/Th 10:00-11:30
T 6:00-9:00
Question 1 (12 points – 3 points each)
In this question, we will explore the link between the banking system and the aggregate money supply
in the economy. Given the assumptions below, you should answer the subsequent parts to this
question. All answers are numbers. Lastly, throughout the problem, assume the bank can adjust total
loans (TL) freely if they want (i.e., they can make new loans and call in old loans at will).
Put your answer in the box. No work need be shown. All answers will be either awarded full credit
(3 points) or no credit (0 points). There is little (if any) math that needs to be done to answer these
questions. Most of the questions can be answered with simple intuition or simple arithmetic (adding,
multiplying, etc.). Calculators are allowed (but you shouldn’t need them).
Baseline assumptions:
1.
2.
3.
4.
The required reserve ratio (m) equals 5%.
Banks only hold required reserves (m* = m).
No one in the economy holds cash outside the banking
system (TC = 0).
Total deposits in the entire banking system equals $1 trillion
(TD = $1 trillion).
a.
Given the baseline assumptions, what is the monetary base (Base) in this economy?
b.
Suppose the required reserve ratio declines to 2.5%. Relative to the baseline scenario, how
much will total reserves (TR) change as a result of the change in the reserve ratio (inclusive
of the subsequent change in banking lending that results)? Assume all other baseline
assumptions hold (aside from m now equaling 2.5%).
c.
Suppose we return to the original baseline scenario (m = 5%). Now suppose that the only
change to the baseline assumptions is that banks now hold excess reserves such that the
desired reserves held by the banks equal 10% of total deposits (m* = 10% > m = 5%).
Assume all other baseline assumptions hold. Given the change in bank behavior (inclusive
of their subsequent change in total loans), what would be the new level of the money supply
(MS) in the economy?
d.
Suppose we return to the original baseline scenario (banks now hold no excess reserves).
Suppose that households are fearful that the banking system will collapse and pull out $1
billion from the banking system (i.e., $1 billion of reserves (TL) leave the banking system
while total currency held outside the banking system (TC) increases by $1 billion). How
much would the money supply (MS) change if households removed $1 billion from the
banking system?
Question 2 (4 points – 2 points each)
Circle all the true statements below pertaining to the Murphy model (as discussed in class).
a.
All else equal, an increase in the marginal propensity to consume out of current income
(holding permanent income constant) will increase the net benefits of increasing government
spending during large recessions (Y << Y*).
b.
A prominent argument against increasing government spending during recessions is the
government spending diverts resources from the private sector and that the government then
uses those resources inefficiently (relative to the private sector).
Question 3 (4 points)
The article “And the Money Comes Pouring In” (Economist (7/15/2006)) recounts that by the end of
fiscal year 2006 (which is September 30 2006) budget deficits were 30% lower than predicted 6
months prior. The reason that deficits were lower resulted from an increase in total tax revenues and
not from changing government spending or transfers. The article then discussed how President Bush
promptly proclaimed that the lower deficits were the result of his tax policy (he believes that he was
on the right side of the Laffer Curve and that by cutting labor income tax rates he actually increased
total tax revenues).
The article disagrees with President Bush’s claim. List one reason (as described in the article) why it
is unlikely that the President’s tax cuts caused government budget deficits to fall. The article gives
many reasons - you just need to describe one. Your answer should not be more than one sentence (it
could even be less than one sentence).