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Answers to Homework #6

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The questions below draw on the material in Chapter 11 and the associated lecture material. 1. What distinguishes money from other assets in the economy? Money is the most liquid asset. 2. What is commodity money? What is fiat money? Which kind do we use? Commodity money may be used for other purposes. Fiat money is useful only as money. 3. What are demand deposits? Why should they be included in the stock of money? Demand deposits are balances in bank accounts that can be accessed on demand by writing a check. They are money, since they are generally accepted as a medium of exchange. 4. Which of the following are money in the U.S. economy? Which are not? Explain your answers by discussing each in terms of the three functions of …show more content…

a Fed purchase of US government securities from the public AR (+) RR rise by a fraction of the increase in AR ER (+) 8. Suppose that the Fed buys $2 million in US government securities from Alexander, a private bond trader. a. Use balance sheets to show the effects of this transaction on the appropriate accounts of a commercial bank and the Federal Reserve. FR CB Assets Liabilities Assets Liabilities US gov sec CB Deposits Dep at FR Checking Dep + 2m + 2 m + 2 m +2m b. Assuming a required reserve ratio of 10% and a banking system that is fully loaned up initially, show the effects on AR, RR, and ER. AR +2,000,000 RR +200,000 ER + 1,800,000 c. What is the maximum possible expansion in the money supply from new commercial bank lending? 1/.1 x 1.8m = 18m d. What is the total change in the money supply, including both the Fed purchase and the lending by banks? Fed purchase + bank lending = Total change 2m + 18m = 20m 9. Why can=t the Fed control the money supply with perfect precision? First, the Fed cannot directly control the lending activity of banks. In particular, banks may choose to hold more excess reserves (as loan-loss reserves or to cash paychecks, for example) and not increase their lending activity. Second, the Fed cannot control the amount of funds that households choose to hold as deposits in banks. Should people choose to hold more cash, the reserves of the banking system would fall and less money

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