Reference no: EM131539733

Assignment

1) This section deals with increase money supply given two scenarios (see "a" and "b" below).

In Westlandia, the public holds 50% of money one (M1) in the form of currency, and the required reserve ratio is 20%.

a) Estimate how much the money supply will increase in response to a new cash deposit of $500 by completing the accompanying table.

(Hint: The first row shows that the bank must hold $100 in minimum reserves - 20% of the $500 deposit - against this deposit, leaving $400 in excess reserves that can be loaned out. However, since the public wants to hold 50% of the loan in currency, only $400 × 0.5 = $200 of the loan will be deposited in round 2 from the loan granted in Round 1.)

b) How does your answer compare to an economy in which the total amount of the loan is deposited in the banking system and the public does not hold any of the loans in currency? (Hint: Complete the table below when none of the loan proceeds held in currency following the example for row 1.)

c) What does this imply about the relationship between the public's desire for holding currency and the money multiplier? Which scenario will contribute more to increase in money supply?

2) Explain how each of the following changes quantity of money (money supply) in the economy.

a. the Fed buys bonds
b. the Fed auctions credit
c. the Fed raises the discount rate
d. the Fed raises the reserve requirement

3) Assume that in a country the total holdings of banks were as follows:

Show that the balance sheet balances if these are the only assets and liabilities.

Assuming that people hold no currency, what happens to each of these values if the central bank changes the reserve requirement ratio to 2%, banks still want to hold the same percentage of excess reserves, and banks do not change their holdings of Treasury bonds? How much does the money supply change by?

The change in money supply affects the economic agents. Suppose the Federal Reserve increases the money supply to boost aggregate demand during recessionary pressure. How does the increase in money supply affect consumer spending and investment? How does it affect the firm or organization you work for? How do the Federal Reserve policies affect us as individuals (households)?

High rate of inflation is considered bad for the economy since it has various costs. What are the costs of inflation? Which of these costs do you think are most important for the U.S. economy? What are your shoe leather costs of going to the bank? How might you measure these costs in dollars? How do you think the shoe leather costs of your college president differ from your own?