MT445_Unit9_Assignment

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Unit 9 [MT445] Unit 9 Assignment: Monetary Policy and Fiscal Policy Your Name: MT445-5: Examine how fiscal and monetary policies affect the U.S. economy. 1. Explain whether each of the following is counted in the M1 measure of the money supply: i. The coins in your piggy bank. Yes. Since it is currency, it is included in the M1 category of the money supply. ii. The funds are in your checking account at First National Bank. Yes. This is among the checking accounts; hence it is included in the M1 measurement of the monetary base. iii. The funds are in your savings account at Second National Bank. No. The M1 money supply does not include them. iv. The traveler's check you have left over from your trip to Germany. Yes. Since it is a traveler's check, it is included in circulation in the M1 category of money. v. The available balance on your American Express card. No. Money supply measures do not include credit cards since they are not included in M1. This is because the total value of all monetary assets constitutes the money supply, whereas liabilities are not included (Obstfeld, 2019). 2. Refer to the simplified balance sheet for a bank and answer the following questions. Assets Liabilities Reserves $10,000 Deposits $70,000 Loans $66,000 Stockholder's equity $6,000 a. If the required reserve ratio is 5%, how much in excess reserves does this bank hold? Show your work. 10,000 – (5% * 70,000) 10,000 – (3,500) = 6,500 dollars b. What is the maximum amount this bank can expand on its loans? Show your work. 10,000 – (5% * 70,000) 10,000 – (3,500) = 6,500 dollars Therefore, the maximum loan extension that the bank may make is 6,500 dollars. 1 of 3

Unit 9 [MT445] c. What will happen to the M1 money supply if it makes the loans under (b) above and those funds are deposited into another bank by the borrowers? Since M1 consists of checking accounts, currencies, travelers' checks, bank deposits, and coins, there might not be a change in the total amount of money in circulation. M1 is not impacted by the quantity of the medium of exchange. 3. Using a-d below, identify and explain each of the following events: a) part of an expansionary fiscal policy b) part of a contractionary fiscal policy c) part of an expansionary monetary policy d) part of a contractionary monetary policy i. The corporate income tax rate is increased. This is among the contractionary fiscal policies. ii. Defense spending is increased. This is among the expansionary fiscal policies. iii. Families are allowed to deduct all daycare expenses from their federal income taxes. This is among the expansionary fiscal policies. iv. The Federal Reserve Bank sells Treasury securities. This is among the contractionary monetary policies. The selling of Treasury securities will decrease economic growth and the amount of currency in circulation. v. The Federal Reserve Bank buys Treasury securities. This is among the expansionary monetary policies. 4. Answer the following questions in a 450–500-word essay. Assume the Federal government runs a budget deficit in the current fiscal year. i. Should the government always be required to balance the budget? Explain why and include the pros and cons. No, it is sometimes necessary for the government to spend more money than it takes in, such as during a war or a recession (Aye et al., 2019). If the government always had to balance the budget, it would not be able to respond effectively to these situations. There are pros and cons to the government not being required always to balance the budget. Some pros include that the government could respond more effectively to wars and recessions. The government could also invest more in long-term projects, such as infrastructure. Some cons include that the government could become more wasteful and indebted. There would also be less incentive for the government to be efficient with its spending. ii. How can the Federal government fund (finance) the budget deficit? 2 of 3

Unit 9 [MT445] The government can pay for its budget deficit in some ways, including selling government assets and bonds and borrowing from individuals, enterprises, and other economic actors. iii. If the Federal government decides to issue U.S. Treasury securities to fund the deficit, what will happen to the level of the national debt, all other factors held constant? The government essentially funds the deficit by pumping additional money into the economy by transferring securities to the Treasury. Nevertheless, this strategy has a finite chance of success since printing more money raises the supply of money in the market more than the availability of services and goods. Inflation occurs, and economic pressure rises as a result of that. iv. Assuming the Federal government and firms compete for the same savers' dollars in the loanable funds market, what will likely happen to interest rates? Interest rates would rise as loan applications increased. The demand for loanable funds is higher when the Federal government and firms borrow money (Aye et al., 2019). This higher demand for loanable funds increases the interest rate because savers can charge a higher interest rate for their loans when the demand for loanable funds is high. Lenders, faced with a choice between the government and private companies fighting for savers' money, would almost certainly favor the former. Most citizens would likely be interested in selling their bonds and assets to the government. Interest earned on a government bond is guaranteed. v. Given your answer under (ii and iii) above, is crowding out more or less likely to occur if Treasury securities fund the deficit? Explain. C rowding out occurs when public spending increases at the expense of private spending (Obstfeld, 2019). Increases in crowding out can be expected in proportion to the degree to which consumptions, investments, and net exports are sensitive to fluctuations in interest rates. Crowding out is prone to occur due to the government's actions to raise the amount of money circulating throughout the economy. Whenever the deficit is paid for with securities, the requirement for loanable money rises, which raises the likelihood of crowding out. Whenever there is a lot of demand for loans, interest rates go up. That makes it harder for businesses to make loans, which slows down investments and stunts economic expansion. 3 of 3

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Unit 9 [MT445] References Aye, G. C., Clance, M. W., & Gupta, R. (2019). The effectiveness of monetary and fiscal policy shocks on U.S. inequality: the role of uncertainty. Quality & Quantity , 53 (1), 283-295. Obstfeld, M. (2019). Global dimensions of U.S. monetary policy (No. w26039). National Bureau of Economic Research. 4 of 3

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