For Questions 7 – 11, assume that no banks wish to hold excess reserves and that...

For Questions 7 – 11, assume that no banks wish to hold excess reserves and that people prefer to hold all of their money in checkable deposits. Additionally, assume that banks are holding zero excess reserves when the Fed first undertakes any of the described actions.For ease in submitting answers you may use "+" in place of "increase," "-" in place of "decrease," and "0" in place of "stays the same." (Don't use the quotation marks.)

9. Suppose the current equilibrium interest rate is 6% while the reserve ratio is 10%. If the Fed sells $10 worth of Treasury bills to commercial banks, the money supply will (increase, decrease) __decrease_ to $ ________, and the interest rate will (increase, decrease) __increase___ to ________ %. Investment spending will (increase, decrease) __decrease____ to $ ________.

10. Now suppose the interest rate is currently 9%, the reserve ratio is 25%, and the Fed would like to adjust interest rates enough to increase Investment spending (I) by $40. The Fed would need to (buy, sell) __buy__ T bills in the amount of $ ________ which would (increase, decrease) the money supply by __200_ and (increase, decrease) interest rates by __6__%.

11. The equilibrium interest rate is currently 6%, while the reserve ratio is 10%. The banking system currently has required reserves of $20 and zero excess reserves. The Fed decides to increase the reserve ratio to 20%. The money supply will (increase, decrease) __decrease____ by $ ________ as a result of this change, causing the interest rate to (increase, decrease) to ___increase__% and investment spending to (increase, decrease) __decrease___ to $ ________.

Solutions

Expert Solution

Answer 7.

If the fed is currently holding the money supply at

$200, the equiliburm interest rate will be 6% and firms will want to undertake $60 of investment spending. It means that equiliburm in the market take place when money demand is equal to money supply and the investment spending is $60 when money supply is $200.

Answer 8.

The resulting equiliburm money supply will be $300 because if government purchased securities than money supply has been increased and the interest rate will decrease to 3%. Investment spending will be increased to $60 to $80. It means maximum change in money supply can be calculated as change in reserve *multiplier.

Answer 9.

The money supply will decrease to $100 and the interest rate will increase from 6% to 9%. Investment spending will be decreased to $60 to $40.

Maximum change in money supply = change in reserve *multiplier

Maximum change in money supply = $10*10

=$100

Answer 10.

The fed would need to buy T-bills in the amount $15 which would increase money supply by $60 and increased interest rate by 5%.

As we know that required reserve = m* demand deposits

Rahul Sunny answered 1 year ago

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