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```					           How is the banking
system like a
magnifying glass?

BERNANKE
Suppose:
C = 100
R = 100
r = 0.2

M = C + R/r
M = 100 + 100/0.2
M = 100 + 500 = 600
Sometimes people
choose to deposit
more of their money
in banks….

BERNANKE
M = C + R/r
50 150
M = 100 + 100/0.2
50 750 800
M = 100 + 500 = 600
Sometimes people
withdraw their money
from banks….

BERNANKE
M = C + R/r
150     50
M = 100 + 100/0.2
150 250 400
M = 100 + 500 = 600
Sometimes the Board of
Governors decreases the
required reserve ratio….

BERNANKE
M = C + R/r
0.1333
M = 100 + 100/0.2
750 850
M = 100 + 500 = 600
Sometimes the Board of
Governors decreases
the discount rate….

BERNANKE
M = C + R/r
150
M = 100 + 100/0.2
750 850
M = 100 + 500 = 600
Sometimes the FOMC
Treasury bills….

BERNANKE
M = C + R/r
150
M = 100 + 100/0.2
750 850
M = 100 + 500 = 600
From Dec. 1, 2007 to Feb. 1, 2009,
the reserve ratio (R/D) has gone
from 14.7% to 176% to 175%
From January 1, 2009 to February 1, 2009
MI fell from \$1,568.9 billion to \$1,534.3 billion.
The Fed increased the required reserve ratio in 1937-38
The Fed increased the required reserve ratio in 1937-38
In late 1999, a lot of
people were worried

BERNANKE
By the time you finally earn your
Ph.D. in Economics, the money
supply may have grown to \$2,000
billion–with \$800 billion in the form
of currency and coin.
Let’s assume that the required reserve ratio is still 0.20
and that banks are not holding any excess reserves.
Soon after graduation, you take a job at the Federal
Reserve and people lose their confidence in the
banking system. They immediately make withdrawals
in the amount of \$40 billion.
Use this information to answer the next four questions.
M = \$2,000 billion
C = \$800 billion
r = 0.20
Withdrawals = /\C = \$40 billion.

21. Before the \$40 billion of withdrawals were made,
the total reserves in the banking system stood at
A. \$640 billion.
M = C + R/r
B. \$440 billion.
C. \$240 billion.         2000 = 800 + R/0.20
D. \$140 billion.
R/0.20 = 2000 - 800 = 1200
R = 240
M = \$2,000 billion
C = \$800 billion
r = 0.20
R = 240
Withdrawals = /\C = \$40 billion.
22. Absent Federal Reserve
counteraction, the with-
drawals will cause the
money supply to
A. increase to \$2,040 billion.
B. decrease to \$1,840 billion.
C. increase to \$2,160 billion.
D. decrease to \$1,960 billion.
M = \$2,000 billion
C = \$800 billion
r = 0.20
R = 240
Withdrawals = /\C = \$40 billion.
22. Absent Federal Reserve       M = C + R/r
counteraction, the with-
drawals will cause the           M = 800 + 240/0.20
money supply to
M = 840 + 200/0.20
A. increase to \$2,040 billion.
M = 840 + 1000
B. decrease to \$1,840 billion.
C. increase to \$2,160 billion. M = 1840
D. decrease to \$1,960 billion.
M = \$2,000 billion
C = \$800 billion
r = 0.20
Withdrawals = /\C = \$40 billion.
R falls from \$240 to \$200 billion.

23. The Federal Reserve could counteract the loss-
of-confidence effect on the money supply by
A. buying \$32 billion worth of T-bills.
B. selling \$32 billion worth of T-bills.
C. buying \$40 billion worth of T-bills.
D. selling \$40 billion worth of T-bills.
What happens
to the money
supply when the
Bills?
What happens
to the money
supply when the
Bills?
R has fallen from 240 to 200
What R is needed to make
M = 2000?

M = C + R/r
2000 = 840 + R/0.20
R/0.20 = 2000 - 840 = 1160
R = 232
/\R = 32
M = \$2,000 billion
C = \$800 billion
r = 0.20
Withdrawals = /\C = \$40 billion.

23. The Federal Reserve could counteract the loss-
of-confidence effect on the money supply by
A. buying \$32 billion worth of T-bills.
B. selling \$32 billion worth of T-bills.
C. buying \$40 billion worth of T-bills.
D. selling \$40 billion worth of T-bills.
M = \$2,000 billion
C = \$800 billion
r = 0.20
Withdrawals = /\C = \$40 billion.

24. Alternatively, the Federal Reserve could
counteract the withdrawals by (You don’t need a
calculator)
A. increasing the required reserve ratio to 24.17%
C. increasing the required reserve ratio to 27.14%.
B. increasing the required reserve ratio to 21.47%
D. decreasing the required reserve ratio to 17.24%.
R has fallen from 240 to 200
What r is needed to make
M = 2000?

M = C + R/r
2000 = 840 + 200/r
200/r = 2000 - 840 = 1160
r = 200/1160 = .1724
r = 17.24%
M = \$2,000 billion
C = \$800 billion
r = 0.20
Withdrawals = /\C = \$40 billion.

24. Alternatively, the Federal Reserve could
counteract the withdrawals by (You don’t need a
calculator)
A. increasing the required reserve ratio to 24.17%
B. increasing the required reserve ratio to 21.47%.
C. increasing the required reserve ratio to 27.14%
D. decreasing the required reserve ratio to 17.24%.
ECON 2030
Second Hour Exam
Prof. R. W. Garrison
We know that M = C + D.

Let’s define the monetary base (B) as
B=C+R
We know that R = rD.

Let’s recognize that people make their own choices
about the preferred ratio of currency to checking-
account money. That is, k = C/D.
We can write C = kD, where k is the preferred proportion.

So, M = C + D = kD + D = (k + 1)D
And B = C + R = kD + rD = (k + r)D
So, M = C + D = kD + D = (k + 1)D
And B = C + R = kD + rD = (k + r)D
So, M = C + D = kD + D = (k + 1)D
And B = C + R = kD + rD = (k + r)D

M       (k + 1)D        (k + 1)
B   =   (k + r)D    =   (k + r)
(k + 1)
M=      (k + r) B
Suppose we know:
C = 500 and R = 100,
k = 0.80 and r = 0.10.

Can you calculate M?
(k + 1)
B=C+R                                M=   (k + r) B
B = 500 + 100
B = 600

M = [(k + 1)/(k + r)] B
M = [(0.80 + 1)/(0.80 + 0.10](600)
M = [1.80/0.90](600)
M = 2(600)
M = 1200
C = 500; R = 200
r = 0.10; k = 0.25
(k + 1)
M=     (k + r) B

Calculate M---using the equation M = C + R/r

M = C + R/r = 500 + 200/0.10 = 500 + 2000 = 2,500

Calculate M again, this time taking “k” into account.

M = (k + 1)/(k + r) [C + R]
M = (0.25 + 1)/(0.25 + 0.10)[500 + 200]
M = 1.25/0.35 [700] = 25/7 [700] = 2,500
C = 500; R = 200
r = 0.10; k = 0.25
(k + 1)
M=     (k + r) B
Let the Fed add 70 worth of reserves.
Calculate M---using the equation M = C + R/r

M = C + R/r = 500 + 270/0.10 = 500 + 2700 = 3,200

Calculate M again, this time taking “k” into account.

M = (k + 1)/(k + r) [C + R]
M = (0.25 + 1)/(0.25 + 0.10)[500 + 270]
M = 1.25/0.35 [700] = 25/7 [770] = 2,750
C = 500; R = 200
r = 0.10; k = 0.25
(k + 1)
M=     (k + r) B
Let the Fed adds 70 worth of reserves.
Explain the difference in results by calculating C & R.

M = C + R/r = 500 + 270/0.10 = 500 + 2,700 = 3,200
C = 500; R = 270        D = 2,700

Note, however, that k = C/D = 500/2,700 = 0.185
C = 500; R = 200
r = 0.10; k = 0.25
(k + 1)
M=     (k + r) B
Let the Fed adds 70 worth of reserves.
Explain the difference in results by calculating C & R.
M = (k + 1)/(k + r) [C + R]
M = (0.25 + 1)/(0.25 + 0.10)[500 + 270]
M = 1.25/0.35 [700] = 25/7 [770] = 2,750
M = C + D = kD + D = (k + 1)D
D = M/(1 + k) = 2,750/(1 + 0.25) = 2,750/1.25 = 2,200
R = rD = 0.10(2,200) = 220
C = B – R = 770 – 220 = 550
k = C/D = 550/2,200 = 0.25
What happens when commercial banks keep a
larger-than-required fraction of their deposits on
reserve? (That is, what happens when r > rreq.)
Should the Fed increase or decrease the
required reserve ratio? Or should it use another
monetary tool?

R
M =C + r                    ( )
The Fed increased the required reserve ratio in 1937-38
The Fed increased the required reserve ratio in 1937-38
According to the Fed’s “Regulation Q,” which was imposed on
the banking system from the mid 1930s until the early 1980s,
no bank account could be both checkable and interest bearing.

Checking accounts,                 Savings accounts
i.e., demand deposits              bear interest but are
can bear no interest.              not checkable.
In the early 1980s---after a bout with double-digit inflation,
“Regulation Q” was phased out, after which the distinction
between checking accounts and saving accounts was blurred.

Checking accounts,                  Savings accounts
i.e., demand deposits               bear interest but are
can bear no interest.               not checkable.
In the early 1980s---after a bout with double-digit inflation,
“Regulation Q” was phased out, after which the distinction
between checking accounts and saving accounts was blurred.

Checking accounts,                  Savings accounts
i.e., demand deposits               bear interest and
can now bear interest.              are effectively
checkable.
In the early 1980s---after a bout with double-digit inflation,
“Regulation Q” was phased out, after which the distinction
between checking accounts and saving accounts was blurred.

Well, we just don’t
know what money is,
anymore.
\$\$ Russia
\$\$ Ukraine
The Fed knows how
much money it has         \$\$\$\$\$                  \$\$ Middle East
created, but it doesn’t
know where in the                   Panama
world it all is.                 \$\$
The equation of exchange was
most useful when most US
dollars were in the US.
\$\$ Argentina
ECON 2030
Second Hour Exam
Any Semester
Pentamber 32, 2001
Prof. Roger W. Garrison
True of False:
Whereas Keynes wanted to use fiscal policy to
manipulate the economy, Friedman wanted to
use monetary policy to manipulate the economy.
True of False:
Whereas Keynes wanted to use fiscal policy to
manipulate the economy, Friedman wanted to
use monetary policy to manipulate the economy.
False
Friedman, who believes that markets work and
the economy doesn’t need any manipulating,
points out that M is often--but shouldn’t be--used
as a countercyclical tool. Changing M is more
likely to cause cycles than to cure them.
Monetarism
MV = PQ
Policy recommendation: Increase M
at a slow, steady rate (2 or 3%) to
match the long-run rate of growth.
Monetarism
MV = PQ
With this “Monetarist Rule” in effect
and a constant velocity of money,
the rate of inflation will be zero.
0. The "velocity of money" is a Newtonian
metaphor that implies measurement in units of
speed. However, this particular macroeconomic
magnitude would more appropriately be
measured in
A. dollars per year (\$/yr).
B. miles per dollar (mi/\$).
C. miles per year (mi/yr).
D. frequency units (times/yr).
6. An increase in the velocity of money can be
understood as
A. a decrease in money hoards, which puts
upward pressure on prices.
B. an increase in money hoards, which puts
upward pressure on prices.
C. a decrease in money hoards, which puts
downward pressure on prices.
D. an increase in money hoards, which puts
downward pressure on prices.
MV=PQ
3. The fact that the money supply is much less

MV=PQ=E=Y
than the dollar value of the economy’s annual
income or output is a reflection of the fact that
A. the velocity of money is greater than zero but
less than one.
B. the velocity of money is considerably greater
than one.
C. the required reserve ratio is considerably less
than one.
D. the velocity of money is the reciprocal of the
required reserve ratio.
8. Thinking in terms of the equation of
exchange and using Keynesian imagery, we
can say that a waning of the animal spirits is
most directly represented by
A. an increase in Q.
B. an increase in V.
C. a decrease in Q.
D. a decrease in V.

MV=PQ=P(QC+QI)
9. The claim that, in the long run, changes in the
price level are almost exclusively attributable to
changes in the money supply
A. is accepted and emphasized by both
Monetarists and Keynesians.
B. is accepted as true by neither Monetarists nor
Keynesians.
C. is accepted as true by Monetarists but is
rejected–or ignored–by Keynesians.
D. is seen as an important truth by Keynesians
but is seen as a trivial truth by Monetarists.
4. The claim that in normal times, the velocity of
money is stable and nearly constant
A. is accepted as true by neither Monetarists nor
Keynesians.
B. is accepted as true by Monetarists but rejected as
false by Keynesians.
C. is accepted as true by Keynesians and
Monetarists alike.
D. is accepted as true by Keynesians but rejected as
false by Monetarists.
5. Consider a period during which the level of

MV = PQ
real output is trending upward. If there is no
change in the money supply and the velocity of
money is constant, then we would expect to see
A. a downward trend in prices.
B. an upward trend in prices.
C. a decreased use of cash relative to checking-
account money.
D. an increased use of cash relative to checking-
account money.
7. The actual production of US currency is
accomplished
A. exclusively by the Federal Reserve Bank of
New York.
B. by each of the Federal Reserve Banks.
C. by the Department of Commerce, which
oversees the nation’s commercial banks.
D. by the Bureau of Engraving and Printing,
which is housed in the Department of the
Treasury.
31. Suppose that new taxes on tobacco products
cause the tax-included price of cigarettes to
double. Microeconomists would predict that the
quantity of tobacco products bought will fall only
slightly and that total spending on cigarettes will
almost double. Monetarists would claim that the
tax will
A. result in a slightly higher rate of inflation.
B. cause the Federal Reserve to undertake
compensatory policy actions.
C. have no effect on the general price level.
D. result in a slightly higher velocity of money.
ECON 2030
Second Hour Exam
Any Semester
Pentamber 32, 2001
Prof. Roger W. Garrison

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