Answered: part-a: What are the components of the…

Economics: Private and Public Choice (MindTap Course List)

16th Edition

ISBN:9781305506725

Author:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson

Publisher:James D. Gwartney, Richard L. Stroup, Russell S. Sobel, David A. Macpherson

Chapter13: Money And The Banking System

Section: Chapter Questions

Problem 15CQ

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part-a: What are the components of the M1 money supply? What are the components of the M2 money supply?

part-b: Explain how 100% reserve banking works. Now explain how fractional reserve banking works.

part-c: Suppose I live in a hypothetical country, Pandesia, where there is 100% reserve banking. I deposit $1,000 in a checking account at the 1st National Bank of Pandesia. Using the T-account (ie: assets on the left and liabilities on the right), explain whether / how my deposit changes the money supply in Pandesia.

part-d: Now suppose the Central Bank of Pandesia (CBP) decides that after centuries of 100% reserve banking, it is time for a change and decide to switch the Pandesian banking system to fractional reserve banking. To begin with, board of governors at the CBP agree on a required reserve ratio of 10%. How does my deposit of $1,000 at the 1st National Bank of Pandesia impact the money supply in Pandesia after this change? Explain by using the T-account.

part-e: Next suppose that Pandesian economy enters a recession. To fight against the unemployment created by the recession, CBP decides to expand the Pandesian money supply. To that end, CBP cuts the required reserve ratio to 5% (recall that used to be 10% previously). How does my $1,000 deposit change the Pandesian money supply? Explain by using the T-account.

part-f: Finally assume that CBP’s expansionary monetary policy (ie: cutting the required reserve ratio from 10% to 5%) is a total success and Pandesian unemployment rate returns back to their natural unemployment rate level. However CBP’s expansionary monetary policy creates unwanted inflation in the country. To fight against inflation, CBP decides to increase the required reserve ratio to 15%. How does my $1,000 deposit change the Pandesian money supply? Explain by using the T-account.

part-g: In this question, CBP used the required reserve ratio to adjust their money supply to first fight against unemployment and then against inflation. Having read chapter-29 of your textbook, what other tools could CBP have used to change their money supply?

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