PRINCIPLES OF MACROECONOMICS(LOOSELEAF)
7th Edition
ISBN: 9781260110920
Author: Frank
Publisher: MCG
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Chapter 14, Problem 7P
To determine
Illustrate the value of change in bank deposits.
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Bank reserves increase by $5,000 when the RRR is 15%. The banks initially hold an additional 1% as excess reserves but then lend out all excess reserves so that the actual reserves are equal to the required reserves. By how much does the money supply increase when the banks change from 1% to 0% excess reserves?
Deriving the aggregate demand curve from the quantity equation of money allows the aggregate demand curve to be written as P = MV / Y. If V = 3, and M = 1,000, then P = 3,000 / Y, and the slope of this function is:
According to your graph, the equilibrium value of money is (0.25, 0.50, 0.75, 1.00) therefore the equilibrium price level is (1.00, 1.33, 2.00, 4.00).
Now, suppose that the Fed reduces the money supply from the initial level of $4 billion to $2.5 billion.
In order to reduce the money supply, the Fed can use open market operations to (sell bonds to – buy bonds from) the public.
Use the purple line (diamond symbol) to plot the new money supply (MS2).
Immediately after the Fed changes the money supply from its initial equilibrium level, the quantity of money supplied is (greater – less) than the quantity of money demanded at the initial equilibrium. This contraction in the money supply will (increase – reduce) people’s demand for goods and services. In the long run, since the economy’s ability to produce goods and services has not changed, the prices of goods and services will (rise – fall) and value of money will (rise – fall)
Chapter 14 Solutions
PRINCIPLES OF MACROECONOMICS(LOOSELEAF)
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- According to the equation of exchange, if the money supply is $700 million, real GDP is $1,600 million, and nominal GDP is $3,220 million, then the velocity of money is equal to:arrow_forward. Based on your knowledge of the Quantity Theory of Money and the Equation of Exchange, answer the following questions. Assume the Bank of Canada has been instructed by the government to maintain a constant price level in the economy. What should it do if the economy experiences a boom in the business cycle that increases the real GDP increases by 3.5%? Explain briefly. Assume the Bank of Canada has been instructed by the government to maintain a constant price level in the economy. What should it do if the velocity of money declines by 2%? Explain briefly. Assume the Bank of Canada has been instructed by the government to maintain a constant price level in the economy. What should it do if the economy experiences a recession in which the real GDP declines by 3%? Explain briefly. Assume the money supply is $1,200 billion, the velocity of circulation is 8, and the price level is $6. What is the level of real output and nominal output? Assume the money supply is $1,200…arrow_forwardFrom 1980 to 2020, the prices of all goods and services in the United States rose by a total of 214%. What does this suggest about the growth of the United States' money stock according to the Quantity Theory of Money? The US money stock decreased by 214% per year from 1980 to 2020. The US money stock increased by 214% per year from 1980 to 2020. The US money stock decreased by a total of 214% from 1980 to 2020. The US money stock increased by a total of 214% from 1980 to 2020arrow_forward
- Since October 2008, the Federal Reserve has started paying interest on excess reserves held by banks. Under these circumstances, if the Fed buys a Treasury security worth $200 million from a bank, which of the following can be expected regarding the change in the money supply? Assume that the required reserve ratio is 10% and that all currency is deposited into the banking system. -The money supply will increase by less than $2 billion. -The money supply will not change at all. -The money supply will increase by $2 billion. -The money supply will increase by more than $2 billion.arrow_forwardAccording to the quantity theory of money, an excess quantity of money supplied will lead to: OPTIONS: a higher price level. a reduced level of real Gross Domestic Product (GDP). a reduction in spending and higher interest rates. a higher level of employment.arrow_forwardThe following graph represents the money market for some hypothetical economy. This economy is similar to the United States in the sense that it has a central bank called the Fed, but a major difference is that this economy is closed (and therefore does not have any interaction with other world economies). The money market is currently in equilibrium at an interest rate of 2.5% and a quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol. Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by placing the new money supply curve (MS) in the correct location. Place the black point (plus symbol) at the new equilibrium interest rate and quantity of money. Suppose the following graph shows the aggregate demand curve for this economy. The Fed's policy of targeting a lower interest rate will (increase/reduce) the cost of borrowing, causing residential and business investment spending to (increase/decrease) and…arrow_forward
- The following graph represents the money market for some hypothetical economy. This economy is similar to the United States in the sense that it has a central bank called the Fed, but a major difference is that this economy is closed (and therefore does not have any interaction with other world economies). The money market is currently in equilibrium at an interest rate of 3% and a quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol. Suppose the Fed announces that it is raising its target interest rate by 75 basis points, or 0.75 percentage points. To do this, the Fed will use open-market operations to (increase/decrease) the (demand for/supply for) money by (buying bonds from/selling bonds to) the public. Use the green line (triangle symbol) on the previous graph to illustrate the effects of this policy by placing the new money supply curve (MS) in the correct location. Place the black point (plus symbol) at the new equilibrium interest rate…arrow_forwardSuppose that while demand for money still depends on Y as specified, it is now no longer affected by the interest rate.arrow_forwardThe claim that increases in the growth rate of the money supply increase nominal interest rates but not real interest rates is known as the A. Friedman Effect. B. Hume Effect. C. Fisher Effect. D. inflation tax.arrow_forward
- The interest rate on reserves is the interest rate that the Fed pays banks for holding reserves on deposit at the Fed. For many years, open market operations were the Fed’s primary tool for monetary policy. However, since October 2008, it relies more on interest on reserves. A decrease in the interest rate on reserves tends to (decrease or increase) the reserve ratio, (decreases or increases) the money multiplier, and (decrease or increase) the money supply.arrow_forwardWhich bond should have the highest interest rate? A. Low quality bonds B. Medium quality bonds C. High quality bonds Which of the following statements is NOT true? A. Stock owners benefit from stock price increases B. Common stocks are not securities C. Stock prices tend to be very volatile D. Higher stock prices allow companies access to more capital What is the expected impact of a decline in the money supply to the US economy? A. Lower aggregate prices (deflation) B. Higher aggregate prices (inflation) C. There is no general relationship between the money supply and inflaton Which of the following is NOT a component of federal fiscal policy? A. Federal tax revenues B. Federal government expenditures C. Federal budget deficit D. All of the above are components of federal fiscal policy A strong US dollar tends to A. Reduce exports to foreign…arrow_forwardLet M subscript t denote the initial money supply. A friend of yours does not trust banks and keeps all his money in cash. He buys an old car for $20,000. The seller deposits the money in her checking account in Citibank. The bank keeps 10% of the deposit in reserve and lends the rest to Jack. Jack keeps $1,000 in cash and spends the remainder on NVIDIA stock. The seller of the stock, Jane, transfers the whole amount to her checking account in Wells Fargo. Wells Fargo keeps 20% of the amount in reserve and lends to rest to Joshua. Joshua keeps $1,600 in cash and spends the rest on treasury securities. The seller of the securities happens to be the Fed. A fire in Joshua's uninsured house destroys $600 of his cash. Let M subscript t plus 1 end subscript denote the resulting money supply. Calculate the change in the money supply, M subscript t plus 1 end subscript minus M subscript t.arrow_forward
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