07 Jun Question Name ______________________________________ last 4 PSU ID ___________
Question
Name ______________________________________ last 4 PSU ID ________________
ECON 104 HOMEWORK #8 (100 POINTS TOTAL)
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 aren’t 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 didn’t work. In the space below, write down what you would say to the chair (i.e., explain why the injection did not work).
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) (10 points) Calculate the total percent change in the monetary base, the money multiplier, and the money supply (from part a) to part e)) and compare to the actual real world percent changes since this crisis began in August of 2007 to the end of 2010. Please use the following links and click “view data” on the upper left to obtain the actual real world values. For the monetary base start in August 2007 (this is monthly data), for the money multiplier start 8/15/07 (bi-weekly data) and for M1 start at 8/13/2007 (also weekly data)).
g) (20 points) Graphing exercise: In the space below, draw two diagrams with a graph of the Monetary Base on the left and the Money Supply on the right. Locate as point A, the conditions that prevailed in part a), locate as point B, the conditions that prevailed in part b), locate as point C, the conditions that prevailed in part d) and finally, locate as point D, the conditions that prevailed in part e). Helpful hints: don’t worry about labeling interest rates, the variable on the vertical axis, since there are none in this problem. Simply draw vertical lines (as we did in the lecture) labeling the value of the MB and MS on the horizontal axis with the appropriate points (A, B, C, D). If the curve doesn’t change (hint, this happens with MS but not MB), simply label it with the appropriate A = B or whichever applies.
Part 2: True/ False 40 points total (2 points each)
1) If the excess to reserve deposit ratio goes up along with the currency to deposit ratio, all else constant, then we are unsure what happens to the money multiplier since the money multiplier is negatively related to the excess reserve to deposit ratio but positively related to the currency to deposit ratio.
2) During each FOMC meeting policymakers discuss the current state of economic affairs in each of the 12 regional districts that make up the US. In fact, the Presidents of all the regional Federal Reserve Banks attend all FOMC meetings and discuss the conditions in their respective districts.
3) If the Fed was worried about overheating (GDP growing too fast, inflationary pressures building), then the appropriate open market operation would be for the Fed to conduct open market sales.
4) The FOMC meets in Washington DC but the action, in terms of conducting open market operations takes place at the New York Fed (FRBNY).
5) During the Great Depression, the excess reserve to deposit ratio rose for a variety of reasons. The impact on the money multiplier was negative. That is, all else constant, a higher excess reserve to deposit ratio lowers the money multiplier.
6) In the lectures, we argued that the money (M1) multiplier (since October 2008) has been rising given that banks have been ‘hoarding’ money (due in part to the fact that the Fed is paying interest on excess reserves) resulting in a rise in their respective reserve to deposit ratios.
7) If the money multiplier is 3 and the Fed conducts $100 billion of open market sales, then the money supply will increase by $300 billion.
8) If the money multiplier falls by 50%, then the Fed, to keep the money supply constant, would have to double the monetary base.
9) Prior to October 2008, the M1 money multiplier was trending downward since the required reserve ratio administered by the Fed was trending upward.
10) According to the quantity theory of money in percent change form, then if velocity falls so that its growth rate is negative then the Fed, to keep inflation and output growth stable, should match the decrease in velocity with an equivalent increase in the percent growth of the money stock.
11) According to Milton Friedman, inflation is always and everywhere, caused by excessive economic growth.
12) The reason that the existence of money increases efficiency in the economy is that it allows society avoid the double coincidence of wants and therefore, allows people to specialize in what they do best.
13) Assuming that the nominal return on money is equal to zero, the real return to holding money is the inflation rate.
14) The largest component of household sector wealth is wealth in the stock market.
15) M2 is more liquid than M1 since M2 includes traveler’s checks where M1 does not.
16) The FOMC meets every month unless conditions warrant more frequent meetings.
17) The Philadelphia Federal Reserve Bank is responsible for monitoring economic activity in their district which includes the economic activity in State College, PA.
18) According to the lecture discussing the October 2012 FOMC statement, the Fed plans on buying $85 billion per month in longer term securities in hopes of lowering long term interest rates.
19) According to the lecture discussing the October 2012 FOMC statement, they plan on keeping their target for the federal funds rate in the range of 0 – .25% at least through mid 2015.
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