ECON 201 - Chapter 17 Problem Set PDF

Preview

Summary

Chapter 17 Problem Set - Money and the Federal Reserve
ECON 201
...

Description

ECON 201 - Chapter 17 Problem Set - Money and the Federal Reserve 1. Suppose that you take $150 in currency out of your pocket and deposit it in your checking account. Assuming a required reserve ratio of 10%, what is the largest amount by which the money supply can increase as a result of your action? $1,500. With a required reserve ratio of 10% the corresponding money multiplier is 10. This result is given by the equation mm = 1/rr. With a money multiplier of 10 and the assumption that banks hold zero excess reserves and all money is deposited, through the process of lending and depositing the initial $150 becomes 10$150 = $1; 500: Technically, the initial $150 deposit is not really \new" money, so it would be deducted out at the end. 2. Consider the balance sheet for the Wahoo Bank as presented below.

Using a required reserve ratio of 10% and assuming that the bank keeps no excess reserves, write the changes to the balance sheet for each of the following scenarios: (a) Bennett withdraws $200 from his checking account. On the liabilities side of the balance sheet, the $200 withdrawal reduces the bank's outstanding liabilities from $4,000 to $3,800. The bank will need to use its assets to fulfill Bennett's request for a withdrawal while still maintaining the required reserve ratio. If it has $3,800 in liabilities, then it

needs $380 in reserves. Therefore, the bank can use $20 from its reserves to fulfill the request. It will get the remaining $180 by reducing the amounts of loans it issues. (b)Roland deposits $500 into his checking account. On the liabilities side, Roland's $500 deposit increases the bank's liabilities by $500. On the assets side, the bank must contribute $50 to its reserves to meet the reserve requirement. The remaining $450 will be loaned out. (c) The Fed buys $1,000 in government securities from the bank. There are no changes on the liabilities side. On the assets side, the bank sells $1,000 of its securities to the Fed and lends out the new money. (d)The Fed sells $1,500 in government securities to the bank. Nothing changes on the liabilities side. Thus on the assets side, required reserves must stay the same. Also, government securities increase by $1,500. To pay for the new assets the bank must reduce its loans by the same amount. 3. Using a required reserve ratio of 10% and assuming that banks keep no excess reserves, which of the following scenarios produces a larger increase in the money supply? Explain why. (a) Someone takes $1,000 from under his or her mattress and deposits it into a checking account. (Assume this is \new" money). (b) The Fed purchases $1,000 in government securities from a commercial bank. Both scenarios will cause exactly the same increase in the money supply. Whether the bank receives $1,000 from a new depositor or $1,000 from the sale of its assets, in either case \new" money is entering the money supply. With a required reserve ratio of 10%, the money multiplier is 10. Thus, whether the $1,000 comes from under a mattress or the Fed's printing press, the result is a $10,000 increase in the money supply. 4. Determine if the following changes affect M1 and/or M2: (a) An increase in savings deposits Savings deposits are only included in M2, not M1. Consequently, M2 increases and M1 stays the same. (b) A decrease in credit card balances Credit card balances are not money. M1 and M2 are unchanged. (c) A decrease in the amount of currency in circulation A decrease in currency will lower M1. Because all of M1 is included in M2, M2 will fall also. (d) The conversion of a savings account into a checking account. Converting a savings account to a checking account will increase M1 because M1 includes checking and not savings. Because M1 is a part of M2, M2 is unchanged, merely its composition changes. 5. What is the simple money multiplier if the required reserve ratio is 15%? If it is 12.5%? When the required reserve ratio is 15%:

M’m=1/rr=1/0.15=6.67 When the required reserve ratio is 12.5%: M’m=1/rr=1/0.125=8 6. Suppose the Fed buys $1 million in Treasury securities from a commercial bank. What effect will this action have on the bank's reserves and the money supply? Use a required reserve ratio of 10%, and assume that banks hold no excess reserves and that all currency is deposited into the banking system. The immediate result will be that the commercial bank will have $1,000,000 in excess reserves, since its deposits did not change. The commercial bank will loan out these excess reserves, and the money multiplier process begins. Under the assumptions of this question, the simple money multiplier applies. Therefore, in the end, $10 million in additional deposits will be created....