Problem Set 4 (1)

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worldwide.erau.edu All rights are reserved. The material contained herein is the copyright property of Embry-Riddle Aeronautical University, Daytona Beach, Florida, 32114. No part of this material may be reproduced, stored in a retrieval system, or transmitted in any form, electronic, mechanical, photocopying, recording or otherwise without the prior written consent of the University. Problem Set 4 Module 6 Problem Set Complete the following problems. Please download the problem set, insert your answers in the Word document, and then submit the completed problem set to the Canvas grade book. 1. Commercial banks supply money to firms and households by making loans. a. List the four functions of money and provide an everyday example of each. Answer: b. Define M1 and M2. Answer: c. In the FRED database, find M2. Paste the graph for the last 10 years here. Answer: d. What is the measurement of M2 (shows the units) and date of the measurement? Answer: e. Characterize the M2 growth over the last 10 years (steady growth, spikes in growth, etc). Answer: 2. The following questions address money creation in the banking system. Assume the Federal Reserve Bank requires commercial banks to hold reserves of at least 10% of total deposits (the required reserve ratio is 10%). a. Where can the bank hold the required reserves? Answer: b. A large bank’s liabilities include $1 billion ($109) in checkable deposits. What are the Required Reserves? Answer:

worldwide.erau.edu All rights are reserved. The material contained herein is the copyright property of Embry-Riddle Aeronautical University, Daytona Beach, Florida, 32114. No part of this material may be reproduced, stored in a retrieval system, or transmitted in any form, electronic, mechanical, photocopying, recording or otherwise without the prior written consent of the University. c. A bank has $100 million in excess reserves that it wishes to lend. If the bank lends to its full capacity and the loaned funds are spent and then repeatedly redeposited into commercial banks (lend-spend-deposit cycle), by how much could the money supply theoretically expand? Answer: d. Explain why the actual money multiplier will be less than the theoretical multiplier. Answer: e. If banks have excess reserves to support lending, but firms and households do not wish to borrow, what effect will this have on the money multiplier? Answer: 3. Central banks, the Federal Reserve Bank in the US, conduct monetary policy. a. List and briefly explain the three monetary controls used by all central banks. Answer: b. The assets of the Federal Reserve Bank are comprised of Treasury and other debt instruments such as mortgage certificates that it has purchased in the conduct of monetary policy. In FRED, find and paste the Total Assets of the Federal Reserve Bank. Answer: c. What are the current total assets in trillions of US dollars? What is the date of the measurement? Answer: d. Explain the correlation between the increase in Fed assets and the M2 money supply during the pandemic-induced recession of 2020 (compare the two graphs). Answer: e. Assume the Federal Reserve Bank wishes to increase the money supply by purchasing $1 trillion of US Treasury certificates from commercial banks. Where does it get the $1 trillion? Answer:

worldwide.erau.edu All rights are reserved. The material contained herein is the copyright property of Embry-Riddle Aeronautical University, Daytona Beach, Florida, 32114. No part of this material may be reproduced, stored in a retrieval system, or transmitted in any form, electronic, mechanical, photocopying, recording or otherwise without the prior written consent of the University. 4. The legislative and executive branches of the federal government conduct fiscal policy through spending and taxes. a. From FRED, paste these three graphs:  Federal Government: Current Expenditures  Federal Surplus or Deficit [-] as Percent of Gross Domestic Product  Federal Debt: Total Public Debt as Percent of Gross Domestic Product. Adjust the date ranges for all graphs from 2000-01-01 to the present (this century). Answer: b. What is the latest annual level of government spending in trillions of dollars? As of what date? Answer: c. Characterize federal government spending over in the 21st century. Are there significant spikes and/or drops? Answer: d. What is the difference between the Federal surplus or deficit and the Federal debt? Answer: e. The graph shows the US federal government typically spends more than its revenue. Where does it obtain the funds for the deficit spending? Contrast the source of funds for the federal government deficit spending and the Federal Reserve Bank’s purchases of Treasury certificates. Answer: f. Under what circumstances can Federal deficit spending provide long-term benefits to the economy? Answer: g. What are the dangers of running continuing federal deficits? Answer:

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Example of shifted curve and explanatory arrows Initial Equilibrium Financial capital S D Interest rate Financial capital S D New Equilibrium Interest rate RGDP AS AD Interest rate Financial capital S D Price index rate worldwide.erau.edu All rights are reserved. The material contained herein is the copyright property of Embry-Riddle Aeronautical University, Daytona Beach, Florida, 32114. No part of this material may be reproduced, stored in a retrieval system, or transmitted in any form, electronic, mechanical, photocopying, recording or otherwise without the prior written consent of the University. 5. Use the following diagrams to illustrate the theoretical effects of expansionary fiscal and monetary policies enacted in response to a severe recession. Within the diagrams, show the shift in supply and/or demand for financial capital in the left panels and the shifts in aggregate supply and/or aggregate demand curves in the right panels. In MS Word, use Insert/Shape, then select and draw a line to show the shifted curve(s). Insert three arrows to show the curve shift, and one each showing the change in the X and Y-axis variables as in the example. Contractionary policies are similarly diagrammed. a. The central bank increases the money supply by purchasing $1 trillion of Treasury certificates in the open market. Answer:

RGDP AS AD Interest rate Financial capital S D Price index rate worldwide.erau.edu All rights are reserved. The material contained herein is the copyright property of Embry-Riddle Aeronautical University, Daytona Beach, Florida, 32114. No part of this material may be reproduced, stored in a retrieval system, or transmitted in any form, electronic, mechanical, photocopying, recording or otherwise without the prior written consent of the University. b. Federal government increases spending, expanding the deficit that it finances by selling US Treasury certificates (borrowing). Answer: c. By comparing Parts A and B, explain how the government borrowing partially offsets the Fed’s expansionary monetary policy. Answer:

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