Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
PROBLEMS 1. Suppose the following data apply: Total Bank Reserves Total Bank Deposits Cash Held by the Public $6 billion Stocks held by public $140 billion $100 billion Gross Domestic Product Interest rate $5 trillion Bonds Held by the Public $220 billion Required reserve ratio 0.05 LO: 2 a. b. c. d. $10 billion How large is the money supply as measured by M1? How much excess reserves are there? What is the money multiplier? What is the available lending capacity? AACSB: Analytic a. b. c. d. 2. 6 percent BT: Application The basic money supply (M1) is transaction account balances and cash. Assuming that the total bank deposits are in transactions accounts the money supply is $110 billion. If the required reserve ratio is 0.05, then banks are required to keep $5 billion in reserve ($100 billion X 0.05). Since banks have total reserves of $6 billion, there is $1 billion in excess reserves. The money multiplier is calculated as 1/(required reserve ratio). Thus, the money multiplier is 1/0.05 = 20. Since there are $1 billion in excess reserves and the money multiplier is 20, there is $20 billion in available lending capacity. Assume that the following data describe the condition of the commercial banking system: Total Reserves: $100 billion Transactions deposits: $800 billion Cash held by public: $100 billion Reserve requirement: 0.125 a. b. c. d. e. f. How large is the money supply (M1)? Are the banks fully utilizing their lending capacity? Explain. What would happen to the money supply initially if the public deposited another $50 billion in cash in transactions accounts? Explain. What would the lending capacity of the banking system be after such a portfolio switch? How large would the money supply be if the banks fully utilized their lending capacity? What three steps could the Fed take to offset the potential growth in M1? LO: 2 3. LO: 3 AACSB: Analytic BT: Application a. The money supply (M1) is $900 billion ($100 cash plus $800 Transactions Deposits). b. In this situation banks are fully utilizing their lending capacity. $100 billion of reserves are required at the required reserve ratio of 0.125. This is calculated as $800 billion in deposits x 0.125. Thus, there are no excess reserves; ER=0 when fully utilizing lending capacity. c. Assuming this $50 billion cash is not new money in the system, i.e., it is part of the $100 billion in cash currently being held, then there will be no change in M1. d. After the additional deposit of $50 billion in cash, now required reserves are $850 billion x 0.125=106.25, and total reserves will initially be $150 billion. Now, therefore, there are excess reserves of $150 billion – 106.25 billion = $43.75 billion. The lending capacity of the banking system is now $43.75*8 = $350 billion. The money multiplier is 1/RR= 1/0.125=8. e. Assuming the lending capacity of $350 billion is fully used, the money supply will rise to $1,250 billion. This consists of the current $850 billion in transactions deposits, $50 billion in cash remaining after the deposit was made, plus $350 billion in new money created through the lending process. f. To offset the potential growth in M1 illustrated in ‘e’, the Fed could increase the reserve requirement, raise the discount rate, or sell bonds in the open market. Suppose the Federal Reserve decided to purchase $10 billion worth of government securities in the open market. a. How will M1 be affected initially? b. How will the lending capacity of the banking system be affected if the reserve requirement is 20 percent? c. How will banks induce investors to utilize this expanded lending capacity? AACSB: Analytic BT: Application When the Fed purchases $10 billion of securities on the open market: a. b. c. M1 will increase by $10 billion, assuming that the sellers of the securities hold the proceeds as cash or deposit them in a transactions account, e.g., checking account. Lending capacity will increase by $40 billion. (A money multiplier of 5 x excess reserves of $8 billion.) As the money supply increases, interest rates go down and investors will want to borrow more funds. 4. LO: 4 Suppose the economy is initially in equilibrium at an output level of 100 and price level of 100. The Fed then manages to shift aggregate demand rightward by 20. a. Illustrate the initial equilibrium (E1) and the shift of AD. b. Show what happens to output and prices if the aggregate supply curve is (1) horizontal, (2) vertical, and (3) upward sloping. AACSB: Analytic BT: Application When the economy is at an equilibrium output of 100 and a price level is 100, the impact of a shift in AD rightward by 20 is illustrated below: (a) Initial equilibrium is E1. (b) Output and price changes vary according to the shape of the AS curve. 1 1 Aggregate supply P1 P5 Aggregate supply P4 AD1 0 0 0 E1 AD2 AD5 0 1 QF 0 AD4 0 E1 R ATE O F OU T PUT RATE OF OUTPUT 1 A gg re ga te su pply P7 P6 A D7 AD6 0 0 0 E1 Q7 1 R AT E O F O U TP U T 5. LO: 3 Illustrate the effects on bank reserve of an open-market sale. (See Figure 14.5) AACSB: Analytic BT: Application An open market sale of government securities by the Federal Reserve would have exactly the opposite effect of the change illustrated in Figure 14.5: 1 Step 1, FMOC sells government bond to the public, who pays by check. Step 2, Funds are withdrawn from buyer’s private bank. Step 3, Private bank’s account at Regional Federal Reserve Bank is debited. 6. How did the money multiplier change when China increased its reserve requirement? (see Headline p. 299) LO: 2 AACSB: Analytic BT: Application When the reserve requirement increased from 10.5 percent to 11 percent, the money multiplier decreased from 9.5 to 9.1.