Macro Eco #9 PDF

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Macro Eco #9...

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1. What is fiat money? Why is fiat money important in the United States today? Fiat money is a currency of exchange established as money by law. Paper and coins are the only forms of legal tender, they need to be officially declared to be acceptable in financial transactions. Fiat money is important in the United States today because it helps us to be able to close transactions.

2. Why is the money multiplier considered to be a potential multiplier rather than an indication of exactly how much multiplication should be expected? The money multiplier basically measures the potential amount of money that the banking system generates. Some banks might choose not to lend their excess reserves and keep acquiring assets and when this happens we have a reduction of the chain reaction by the amount of excess reserves not loaned out. Also, borrowers may not spend all their bank deposits, and others may put borrowed funds into time deposits, which would have a reduction of the M1 expansion process but won’t have a reduction of the M2 money expansion process. 3. What are the inherent disadvantages of a barter system? The barter system has been used for a long time even before money was invented and it is used for exchange services and goods for other services and goods in return. I think one of the disadvantages of a barter system is that it requires time to evaluate the value of goods in order to offered for barter and also in the long run it becomes very expensive. Another big disadvantage of a barter system is that sometimes buyers may not have the same value of goods and services to exchange with the seller. This will lead the buyer to exchange more than usual goods or services in order to receive the goods and services from the seller.

4. Calculate M1 and M2 using details from the table given below.

Currency Checkable deposits Traveler's checks Savings deposits Small-denomination time deposits Non institutional money market mutual fund shares Money market deposit accounts

Value (in millions) $75 50 100 125 185 50 25

M1= Currency ($75) + Checkable deposits ($50) + Traveler’s checks ($100) = $225

M2= M1 ($225) + Savings deposits ($125) + Small-denomination time deposits ($185) +Non institutional money market mutual fund shares ($50) + Money market deposit accounts ($25) = $610

5. If you deposit $8,000 in a bank, calculate how much the bank must keep as required reserves and how much it can loan out if the required reserve ratio was 5percent. If it was 8 percent? 13 percent? 26 percent? Deposit= $8,000, Ratio= 5% With a ratio of 5 percent, required reserves = $400 and loanable funds = $7,600. Deposit= $8,000, Ratio= 8% With a ratio of 8 percent, required reserves = $640 and loanable funds = $7,360. Deposit= $8,000, Ratio= 13% With a ratio of 13 percent, required reserves = $1,040 and loanable funds = $6,960. Deposit= $8,000, Ratio= 26% With a ratio of 26 percent, required reserves = $2,080 and loanable funds = $5,920.

6. Name four primary functions of the central bank. The central bank has the job to perform transfers between any commercial bank or other funds exchange into the banking system. They serve as the primary bank for the central government and they also serve as a cash deposit bank for members. Fourth, the central bank buys and sells foreign currencies and generally assists in the completion of financial transactions with other countries. In addition, they also monitor and regulate economic activity through the monetary system.

7. Outline to the policy choices for contractionary and expansionary options of the Fed. The Fed will engage in an expansionary monetary policy to increase employment and reduce unemployment by increasing money supply and decreasing the interest rate. With this process, firms will be able to invest in new equipment and households will increase their investment in housing. When the Fed increases the money supply, interest rates fall, and there is more demand in quantity of goods and services. The Fed may engage in contractionary monetary policy if the economy faces an inflationary gap. If firms are producing beyond normal capacity, and there is a low unemployment rate with a rise on prices, inflation occurs. To combat inflation, the Fed

may engage in an open market sale of bonds, that will lead to a decrease in the money supply, and an increase of the interest rate. With this process, borrowing is more expensive and the return to saving is higher. When the Fed decrease the money supply, interest rate increases, while demand in quantity of goods and services decreases....