03 Jun Question Part 1: (60 points total) Money Supply Problem You are hired by the Chair of the Federal Reserve to manage the trading desk at the New York Fed and
Question
Part 1: (60 points total)
Money Supply Problem
You are hired by the Chair of the Federal Reserve to manage the trading desk at the New York Fed and
the Chair tells you that he wants you to increase the money supply (M1) by 33 percent. He/she warns
you to be careful because in these uncertain times, the money multiplier tends to become very unstable.
He/she suggests that you stay closely connected with the banking sector and he gives you a list of
phone numbers to do so. Note that in this problem we are targeting the growth rate of M1.
Reserve Market
Initial Conditions
rr/D= .10
C = 400 b
D = 2000 b
ER = 00 (not a typo)
M=C+D
a) (6 points) Show your work!
i.
Calculate the MB.
ii.
Calculate the money multiplier.
iii.
What is the money supply (use mm x MB to calculate this)?
So you decide to inject $100 billion in reserves via open market purchases with phone in hand. Recall, the
Chair said to watch that multiplier and so you start making some calls. Just as you suspected, the banks
arent making any loans, that is, they are sitting on all $100 billion in excess reserves.
b) (6 points) Given these new conditions, redo part a).
c) (6 points) Now the Chair calls and asks you how things are going and you tell him/her that you
injected $100 billion in the system but it didnt work. In the space below, write down what you
would say to the chair (i.e., explain why the injection did not work).
1
Now you get some calls from bankers and you learn that there has been some internal substitution within
the M1 money supply. In particular, households prefer to hold more currency relative to deposits, i.e., the
currency to deposit ratio rises. The numbers are as follows:
rr/D= .10
C = 800 b
D = 1600 b
ER =100 b
d) (6 points) redo part a)
e) (6 points) Now the Chair is not pleased with your work, and calls again. Assuming that the
money multiplier is now stable (i.e., the value in part d), what must you do, in terms of open
market operations, to hit the 33 percent money growth rate desired by the chair and the FOMC?
Please show all work!
f)
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