Question

3. Using the money supply (M1) model developed in class, explain the likely effects on the money supply of the following. Be sure your answer indicates what changes in the model.

a. the U.S. Treasury spends some of its account at the Fed

b. the Fed does an open market sale of bonds

c. banks lower the fees they had charged depositors each time a depositor uses a debit or credit card to buy goods or services

d. the Fed increases the interest rate it pays banks on reserves

e. banks borrow more from the Fed at the discount rate

Answer 1

ans....
a) If US treasury spends some of its accounts at the Fed, it will increase money supply as Fed will have a larger monetary base.
b) When Fed does an open market sale of bonds, it leads to money being taken out of the banks and thus decreases the money supply.
c) If banks levy less fees on debit and credit cards, it will encourage depositers to spend more money thus increasing money supply.
d) When the Fed increases the interest rate it pays banks on reserves, this motivates banks to hold more and more reserves as compared to deposits. This increase in reserve-deposit ratio will result in a lower money multiplier. A lower money multiplier will cause decrease in money supply.
e) Discount rate is the interest rate that Fed charges commercial banks in order to borrow money from it. Now suppose, if discount rate falls, this will encourage banks to borrow more from the Fed, which will increase excess reserves in commercial banks and increase the money supply.