Download Solutions for the selected problems:

Solutions for the selected problems:
Chapter 22:
Problem 4
Decrease the reserve ratio: that would immediately free up reserves (create excess
reserves) system wide. Banks could lend more expanding the money supply.
Decrease the discount rate: encouraging banks to borrow reserves and lend more money,
expanding the money supply.
Buy government bonds: The Bank of Japan pays with cash or by increasing deposits in
banks’ accounts. This increases reserves in the system and expands the money supply.
Problem 6
1148 billion x (10%)=114,8 billion in reserves.
The new level of Ms should be calculated as follows:
Ms x (11%) = 114,8 billion
Ms = 1044 billion (in terms of $). So, raising the required reserve ratio (RRR) from 10% to
11% would reduce the money supply by $104 billion (1148 billion – 1044 billion=104
billion).
Chapter 23:
Problem 1
(a) Disagree. A rise in Y increases the demand for money as more transactions take place,
but the supply of money is unaffected.
(b) Disagree. Ceteris paribus, a rise in P means that each transaction is more expensive
and households and firms need to hold more money, not less.
(c) Disagree, again. When the Fed buys bonds, it expands the money supply. The supply
curve shifts to the right. When we experience a recession (Y falls) the demand for
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money falls, shifting the demand curve to the left. Both tend to push interest rates
lower.
Problem 4
This is what Keynes called a “liquidity trap.” Expanding money supply would not push
interest rates lower. The public would essentially hold as much money as we inject into
the system. Since, as you will see, monetary policy works through lowering or raising
interest rates, it will not work to stimulate the economy if the money demand curve is flat.
Problem 5
(a)
r
(b)
Ms
r
r2
r2
r1
r1
Md
0
M
M 0s M 1s
M 1d
M 1d
M 0d
M
0
M
2
Problem 9
The equilibrium is at r .5 or 50 percent,
(a,
b)
.75
which is found as the intersection of the
B
d
M2
.50
.30
A
M
money demand and money supply curves.
Alternatively,
we
algebraically
by
can
solve
s
setting
for
r
Md  M s:
10,000  10,000 r  5,000  10,000
d
.10
0
M1
5,000
10,000
Money
(c)  r  5,000 10,000  .5 .
15,000
17,500
With Y  7,500 , the intersection occurs at
r .75 .
Algebraically,10,000  10,000 r  7,500  10,000
(d)  r  7,500 10,000 .75 or 75 percent. The
money demand curve shifts right.
We need a money supply equal to what
money demand would be when r .5 .
M d  10,000 10,000 .5   7,500  12,500 .
Increase the money supply by $2,500, to
$12,500.
(e) One possibility is that the price level has fallen, shifting the money demand curve back
to its original position.
Chapter 24:
Problem 5
a) Tightening monetary policy implies that Ms↓ → r↑ → I↓ → AE↓ → Y↓ → Md↓ and
at the same time a tax cut (tax↓) → Y↑→ Md↑ → r↑. Because the two policies have
opposite effects on AE, the result is ambiguous. The only thing certain is that r will
rise because the tax cut leads to an increase in M d .
b) In 1998, a tax cut (tax↓) → Y↑→ Md↑ (and if the Ms is held constant) → r↑. In 19992000, when consumption (C) falls → Y↓ → Md↓ (and if the Ms is held constant) →
r↓.
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c) Tax↑ → Y↓ → Md↓ → r↓. And at the same time an expansionary monetary policy is
implemented, then Ms↑ → r↓ → I↑ → AE↑ → Y↑. The compound effect on Y is
uncertain, because increasing tax and expanding Ms have opposite effects on Y. But,
there is no doubt that r would fall.
d) Consumption (C)↓ → AE↓→ Y↓ → Md↓ (if Ms is fixed constant) → r↓. The fall in r
may stimulate the I and offset the initial fall in Y.
e) Ms↑ → r↓ → I↑ → AE↑ → Y↑. But, if the businesses are pessimistic about the future,
investments woud fall and AE↓→ Y↓ → Md↓ and r may decline accordingly. There is
no doubt that r would fall, but the final effect on Y is not certain.
Problem 6
a) I↑ → AE↑ → Y↑ → Md↑ → r↑. So, the Fed should increase Ms in order to hold down
r.
b) Ms↓ → r↑. So, Fed makes Ms↑ and bring the rate of r back to its original level.
Consequently; Y, C, S, I, and Md remain constant.
Problem 7
a) I↓ → AE↓ → Y↓ → Md↓ and if Ms, T, and G remain constant then, r would finally
fall which in turn leads to a rise in I .
b) Option 3 is the most expansionary, because the increase in Ms would lead to a fall in r
and I (and also Y) increases accordingly. Option 2 would come next, but involve some
crowding out effect, because selling bonds to public would decrease the Ms and lead
to an increase in r. Option 1 would be the least expansionary policy, because tax↑ →
consumption expenditure and Y↓.
Problem 8
Investment may not respond positively to low interest rates during a recession because
decreased production may have left the firm’s existing capital underutilized. In this case, there
would be no incentive to buy new plant and equipment. Investment may not respond
negatively to high interest rates during a boom because the increased consumer demand
arising from increased income may make expansion profitable despite the higher cost of
borrowing.
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