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Imsb T6
Imsb T6
“The money multiplier is necessarily greater than 1.” Is this statement true, false, or
uncertain? Explain your answer.(group1)
Solution 1
m=
m = money multiplier
c = currency ratio
r = required reserve ratio
e = excess ratio
If r + e are greater than 1, m will be less than1. If r + e are less than 1, m will be
greater than 1. In conclusion, the answer is uncertain.
Question 2
“If reserve requirements on checkable deposits were set at zero, the amount of
expansion would go on indefinitely.” Is this statement true, false, or uncertain?
Explain. (group1)
Solution 2
R=RR+ER
RR=r*D
>R=(r*D)+ER
So RR=r*D(=0)
R=0(r*D=0)+ER
>R=ER
The total amount of reserves equals excess reserve.
Because R=ER, ER do not make additional loans, so this ER do not lead to the
creation of deposits. Therefore, if the fed injects reserves into the banking system,
and they are held us excess reserves, there will be no effect on deposits or currency
and hence no effect on the money supply.
3. During the Great Depression years 1930-1933, the currency ratio c rose
dramatically. What do you think happened to the money supply? Why? (group2)
The money supply fell sharply because when currency ratio rose, there was a shift
from one component of the money supply (checkable deposits) with more multiple
expansion to another (currency) with less. Overall multiple deposit expansion fell,
leading to a decline in the money supply. A large increase in the currency ratio
(brought on by a fear of bank failures) caused the money multiplier to fall sharply.
Since the money supply is defined as the multiplier times the monetary base, the same
number of reserves and currency created less money during this period. The money
supply fell, even though the central bank did make an attempt to increase the
monetary base.
4. During the Great Depression, the excess reserves ratio e rose dramatically. What do
you think happened to the money supply? Why?(group2)
The money supply model predicts that when {ER/D} and {C/D} increase, the money
supply will fall. The rise in {C/D} results in a decline in the overall level of multiple
deposit expansion, leading to a smaller money multiplier and a decline in the money
supply, while the rise in {ER/D} reduces the amount of reserves available to support
deposits and also causes the money supply to fall.
6. If Jane Brown closes her account at the First National Bank and uses the
money instead to open a money market mutual fund account, what happens to
M1 and M2? Why?
8. Why might the procyclical behavior of interest rates (rising during business
cycle expansions and falling during recessions) lead to procyclical movements
in the money supply?
The rise in interest rates in a boom increases the cost of holding excess
reserves and the incentives to borrow from the Fed. Therefore, e falls, which
increases the amount of reserves available to support checkable deposits, and
the volume of discount loans increases, which raises the monetary base. The
result is a higher money supply during a boom. Similarly, when interest rates
fall during a recession, the money supply also has a tendency to fall because e
rises and the volume of discount loans falls.
9. The Fed buys $100 million of bonds from the public and also lowers r. What will
happen to the money supply?(group4)
10. The Fed has been discussing the possibility of paying interest on excess reserves.
If this occurred, what would happen to the level of e? (group4)
When the Fed pays interest on excess reserves, the banks are more willing to have
more excess reserves. According to the equation above and assume D is fixed, when
the ER increase, the level of e will increase.
(We assume D will be fixed because paying interest on excess reserve from the Fed to
the banks will not affect the willingness of people to save their money)
11.IF the Fed sells $1 million of bonds and banks reduce their borrowings from the
Fed by $1 million, predict what will happen to the monet supply. (group5)
With the nonborrowed monetary base MB unchanged, more Discount loans from
the Fed provide additional borrowed reserves (and hence higher MB) to the banking
sys-tem, and these are used to support more currency and deposits. The result is : The
money supply is positively related to the level of borrowed reserves, BR, from the
Fed. In this question , the Fed reduce ,so the money supply will fall down ,too.
12. Predict what will happen to the money supply if there is a sharp rise in the
cunency ratio.
The money supply falls. The rise in c means that there has been a shift from deposits which
undergo multiple deposit expansion to currency which does not. Thus overall level of multiple
expansion declines, and the money multiplier and money supply fall.
13.What do you predict would happen to the money supply if expected inflation
suddenly increased?(group5)
When inflation increases, money supply will increase to meet the ever more
expensive price.
14. If the economy starts to boom and loan demand picks up, what do you predict
will happen to the money supply?
An increase in loan demand will cause the market interest rate to rise. Higher interest
rates will cause banks to reduce their excess reserves, leading to a decrease in e. A
lower excess reserve ratio suggests a larger money multiplier and an increase in the
money supply.
15. Milton Friedman once suggested that Federal Reserve discount lending (and
borrowed reserves) should be abolished. Predict what would happen to the
money supply if Friedman’s suggestion were put into practice. (group 3)