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Activities 38 - 39. The fed’s open market policy and Money supply. The FED wishes to decrease the money supply from $353 to $303 by open market operations. 1. will the FED buy or sell existing Treasury securities? 2. what is the money multiplier?

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Activities 38 - 39

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Activities 38 39 l.jpg

Activities 38 - 39

The fed’s open market policy

and

Money supply


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The FED wishes to decrease the money supply from $353 to $303 by open market operations

1. will the FED buy or sell existing Treasury securities?

2. what is the money multiplier?

3. what is the value of Treasury securities that need to be bought or sold?

38.1


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The FED wishes to decrease the money supply from $353 to $303 by open market operations

1. will the FED buy or sell existing Treasury securities? sell

2. what is the money multiplier? 10

3. what is the value of Treasury securities that need to be bought or sold? $5

38.1


38 5 suppose banks keep zero excess reserves and the reserve requirement is 15 l.jpg

5. what is the deposit expansion multiplier?

6. a customer deposits $100,000 in her checking account

How much of this can the bank lend to new customers?

How much must the bank add to its reserves?

In what two forms can a bank hold the new required reserves?

7. Suppose that the $100,000 had previously been held in Federal Reserve notes under the customer’s mattress and that banks continue to hold no excess reserves. By how much will the customer’s deposit cause the money supply to grow?

38.5 suppose banks keep zero excess reserves and the reserve requirement is 15%


38 5 suppose banks keep zero excess reserves and the reserve requirement is 155 l.jpg

5. what is the deposit expansion multiplier? 6.67

6. a customer deposits $100,000 in her checking account

How much of this can the bank lend to new customers? $85,000

How much must the bank add to its reserves? $15,000

In what two forms can a bank hold the new required reserves? Vault cash or a Federal Reserve account

7. Suppose that the $100,000 had previously been held in Federal Reserve notes under the customer’s mattress and that banks continue to hold no excess reserves. By how much will the customer’s deposit cause the money supply to grow?

$566,110

38.5 suppose banks keep zero excess reserves and the reserve requirement is 15%


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8. would a very low discount rate (encourage banks to borrow or discourage banks from borrowing) from the Federal Reserve? Why?


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8. would a very low discount rate (encourage banks to borrow or discourage banks from borrowing) from the Federal Reserve? Why?

A bank would be encouraged by a very low discount rate to borrow from the Fed, if it could make loans to new customers at a higher rate. It would have an incentive to make a profit.


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9. the federal funds rate is the interest rate at which financial institutions can borrow from other financial institutions. Suppose the federal funds rate is 5% and the discount rate is 4.5%. Why is it that a bank might choose to borrow in the federal funds market rather than getting the lower interest rate available through the discount window?


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9. the federal funds rate is the interest rate at which financial institutions can borrow from other financial institutions. Suppose the federal funds rate is 5% and the discount rate is 4.5%. Why is it that a bank might choose to borrow in the federal funds market, rather than getting the lower interest rate available through the discount window?

Banks can borrow from one another without oversight.

If a bank was to borrow from the FED, the lender of last resort, it might invite supervision or shake confidence of its investors


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  • 10. in one country the reserve requirement is 100%. What will be the deposit expansion multiplier?

  • 11. If the Fed decided to implement a policy action designed to increase the money supply, in which direction would bank reserves and the federal funds rate change and why?


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  • 10. in one country the reserve requirement is 100%. What will be the deposit expansion multiplier?

  • One

  • 11. If the Fed decided to implement a policy action designed to increase the money supply, in which direction would bank reserves and the federal funds rate change and why?

  • Bank reserves would increase

  • The federal funds rate would decrease


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The money market

The loanable funds market

When the FED buys bonds from bank customers, it pays for bonds, increasing customer’s checkable deposits, which increases bank reserves, which allows banks to make more loans

MS

s

MS1

s1

Nominal interest rate

Real interest rate

d

Dm

Q

Q1

Q

Q1

Quantity of money

Quantity of loanable funds


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The money market

When the Fed increases the money supply

What happens to the interest rate?

What happens to the quantity of money demanded?

What happens to loans and interest rates?

39. When the FED buys bonds from bank customers, it pays for bonds, increasing customer’s checkable deposits, which increases bank reserves, which allows banks to make more loans

MS

MS1

Nominal interest rate

Dm

Q

Q1

Quantity of money


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The money market

When the Fed increases the money supply

What happens to the interest rate? It declines

What happens to the quantity of money demanded? It remains the same

What happens to loans and interest rates?

39. When the FED buys bonds from bank customers, it pays for bonds, increasing customer’s checkable deposits, which increases bank reserves, which allows banks to make more loans

MS

MS1

Nominal interest rate

Dm

Q

Q1

Quantity of money


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The money market

The loanable funds market

When the FED buys bonds from bank customers, it pays for bonds, increasing customer’s checkable deposits, this initial increase in deposits, which increases bank reserves, allows banks to make more loans at a lower interest rate and the money supply is increased by the deposit multiplier

MS

s

MS1

s1

Nominal interest rate

Real interest rate

d

Dm

Q

Q1

Q

Q1

Quantity of money

Quantity of loanable funds


Suppose the demand for money increases l.jpg

The money market

What happens to the interest rate?

What happens to the quantity of money supplied?

If the fed wants to maintain a constant interest rate, what policy must it take?

Why might the Fed want to maintain a constant interest rate?

Suppose the demand for money increases?

MS

Nominal interest rate

Dm1

Dm

Q

Quantity of money


Suppose the demand for money increases17 l.jpg

The money market

What happens to the interest rate? It rises

What happens to the quantity of money supplied? It stays the same

If the fed wants to maintain a constant interest rate, what policy must it take? It must increase the money supply

Why might the Fed want to maintain a constant interest rate? To stabilize the amount of private investment, to prevent recession

Suppose the demand for money increases?

MS

MS1

Nominal interest rate

Dm1

Dm

Q

Q1

Quantity of money


Suppose there are two money demand curves dm and dm1 and the fed increases the money supply l.jpg

The money market

What happens to the interest rate with each money demand curve?

What effect would the increase on money supply have on

Consumption

Investment

Real output

Price level

How, in economic terms, would you describe the two money demand curves?

If the Fed is trying to keep the economy out of a recession, which curve would it prefer to represent the economy?

Suppose there are two money demand curves – Dm and Dm1 – and the Fed increases the money supply

MS

MS1

Nominal interest rate

Dm

Dm1

Q

Q1

Quantity of money


Suppose there are two money demand curves dm and dm1 and the fed increases the money supply19 l.jpg

The money market

What happens to the interest rate with each money demand curve? Interest rates decrease with either, more with MD1

What effect would the increase on money supply have on

Consumption rises

Investment rises

Real output rises

Price level rises

How, in economic terms, would you describe the two money demand curves? MD1 is more interest inelastic than MD

If the Fed is trying to keep the economy out of a recession, which curve would it prefer to represent the economy? It would prefer MD1, a small change in money supply produces a bigger response

Suppose there are two money demand curves – Dm and Dm1 – and the Fed increases the money supply

MS

MS1

Nominal interest rate

Dm

Dm1

Q

Q1

Quantity of money


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