Question

Question 2. During the 1930’s, there were a number of (commercial) bank failures. Please answer all of the following questions (a-f) a. What does it mean for a bank to fail (i.e. provide a definition for a bank failure). b. What actions do individuals take when banks begin to fail? c. What actions do commercial banks take when the rate of bank failures begins to rise? d. What effect did the actions of individuals (from part b) and banks (from part c) have on the money supply? Explain. e. The central bank advocated open market purchases. Would these purchases have reversed the change in the moneys supply? f. Describe the role of the central bank as “lender of last resort”. Question 3. Evaluate the following statement: “In the long run, an increase in the growth rate of the money supply leads to an increase in the real interest rate, but no change in the nominal rate.” (Tell me whether you think the statement is true or false, and then explain why in detail). Question 4. Please answer all three parts to this question. a. Write down the quantity equation, in both the level and the rates of change form. What do each of the terms represent? b. If the Bank of Canada wishes to maintain inflation at 2% per year, how can the bank use the quantity equation to achieve this goal? What assumption is made about the velocity of money? c. Does the Bank of Canada target the rate of growth of M1 (the money supply) or the inflation rate? Why? Question 5. Use this table to answer part (a) of question 5. Please answer both parts of this question which appear below the table. Table A Country Currency Currency per Canadian Dollar Canadian Price Index Country Price Index Bolivia Boliviano 8.00 100 700 Japan Yen 125.00 100 25,000 Morocco Dinar 10.00 100 1200 Norway Kroner 6.5 100 650 Thailand Baht 40.00 100 4000 a. Do all of the currency values in this table (Table A) satisfy the predictions of purchasing power parity? If not, which ones are over-valued, and which ones are under-valued? b. Do you think Purchasing Power Parity is a reasonable prediction for all goods? That is, when might PPP a good job of predicting prices, and what might prevent it from doing a good job of predicting prices. Question 6. In your own words, explain interest rate parity. Do we observe interest rate parity in the real-world data (e.g. between Canada and the United States)? Why or why not? Question 7. Use diagrams for the market for loanable funds and the market for foreign currency to describe what would happen to Net Capital Outflow, the Canadian Real Exchange Rate and Net Exports if the government budget deficit increases. Question 8. Explain how the relation between the real exchange rate and net exports explains the downward slope of the demand curve for foreign-currency exchange.

Answer 1

a) Bank failure

Bank failures occur when banks become insolvent and are unable to meet its financial obligations to depositors. in such a scenario the market value of assets falls below the market value of liabilities making the bank illiquid. In such a case the depositors loose faith in the commercial banks and all starts withdrawing their money simultaneously which adds to the problem of bank, leading to bank run.

b) Actions taken by individuals when bank fail

Situation like bank failure creates a panic among the individuals and they start to believe that bank may cease to operate in near future. Therefore they start withdrawing there deposits in large number because the deposits have now become extremely risky and unviable.

c) Actions taken by commercial banks

1) They look at central bank to help as its the lender of lat resort.

2) Ask government for help

3) They may look for organisations which may take over the bank by acquiring its shares and ownership rights and hence infusing funds.

d) Effect on money supply

Due to bank failures there will be contraction in money supply which might increase the unemployment in the country and will create recessionary tendencies in the economy. Since bank run is all about shortage of money it will undoubtedly decrease the money supply.

e) Central bank advocated open market purchases

When central bank participate in open market it affects the money supply. If the central bank is making open market purchases than the money supply will increase, hence reversing its initial impact. It happens because when central bank is purchasing from the commercial banks in return of it, central bank will give them funds, and money supply in the economy will increase.

f) Central bank as lender of last resort

Central bank is called lender of last resort because its an financial institution which is willing to provide loans/credits as a last resort i.e, when commercial banks are unable to get funds from elsewhere. Moreover central bank ensures that during crisis financial stability of an economy is maintained.