Question

1. Knowing what you know about the functions of money and other desirable properties, including liquidity and acceptability, differentiate the Rai stone of the island of Yap from the bitcoin. (4)

2. Describe the three basic tools used by the Fed to change the money supply. Which of these tools is most relied on in practice? Least relied on? Why? (3)

3. How can the Fed increase the money supply? How can the Fed decrease the money supply? Be specific by explaining why the Fed would make these changes and what the over-all effect is. (3)

4. Discuss the determinants of the equilibrium interest rate and how it may change. What can the Fed do to change the interest rate? (3)

5. If the required reserve ratio = 20% and you deposit $500 into your bank account, how much of it will the bank have to set aside in its required reserve account?__________ How much will be left over to place into excess reserves (ER)?__________. Now, once ER changes occur, how much money can ultimately be created by our banking system? __________. (3)

6. Now what if the required reserve ratio is changed to 10% and you deposit $500 into your bank account, how much of it will the bank have to set aside in its required reserve account?__________ How much will be left over to place into excess reserves (ER)?__________. Now, once ER changes occur, how much money can ultimately be created by our banking system? __________. (3)

7.  Address the inside and outside lags associated with fiscal and monetary policy.  If one policy suffers more significant lags, why use it? (3)

8.  Read "Did the Fed Cause the Great Recession?" (Pages 454-455).  Provide your thoughts on this historical downturn in our economy.  Distinguish the culprit(s).  How is the banking crisis a strong case for moral hazard? (3)

Answer 1

Answer 1:

Yai island money was mainly stone money which was liquid and acceptable and could be usd to purchase any commodity in the market. It was not a digital means of payment to the government. On the other hand, bitcoin is a digital means of payment and is also acceptable but not to all kinds. It is used by some to invest their money.

ANswer 2:

The three most important tools that Fed has are - Reserve Requirements, Discount rate and Open market operations. The most relied upon tool is open market operations because it helps the firm in controlling day to day liquidity in the market. The least relied upon tool is Discount rate because transmission mechanism is weak in case of discount rate.

Answer 3:

To increase the money supply, Fed has to reduce interest rate which decreases the cost of investment and increases aggregate demand. This can be increased by reducing discount rate, reducing reserve requirements and purchasing government securities in the open market.

To decrease the amount of money supplied in the economy, The fed increases rate of interest which makes investment costlier and money supply can be decreased by increasing reserve requirements and discount rate and also selling government securities in the open market.

Answer 4:

In the money market, moeny demand and money supply determines the level of interest rate in the economy. As money demand increases rate of interest increases and as money demand decreases, the rate of interest decreases. The Fed can increase money supply to reduce the rate of interest in the economy and can decrease money supply to increase the rate of interest in the economy.