Principles of Economics (12th Edition)
12th Edition
ISBN: 9780134078779
Author: Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher: PEARSON
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Question
Chapter 25, Problem 6.2P
To determine
To discuss the difference in the impact on money supply due to using a fiscal surplus to buy back bonds and using open market operations to buy them.
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The U.S. money supply (M1) at the beginning of 2015 was $2,683.3 billion broken down as follows: $1,165.7 billion in currency, $3.5 billion in traveler's checks, and
$1,514.1 billion in checking deposits.
Suppose the Fed decided to increase the money supply by decreasing the reserve requirement from 11 percent to 10 percent. Assume all banks were initially
loaned up (had no excess reserves) and the quantity of currency and traveler's checks held outside of banks did not change.
How large a change in the money supply would have resulted from the change in the reserve requirement?
The money supply would change by $ billion. (Round your response to two decimal places and include a minus sign if necessary.)
2. The theory of liquidity preference and the downward-slopingaggregate demand curve
The following graph shows the money market in a hypothetical economy. The central bank in this economy is called the Fed. Assume that the Fed fixes
the quantity of money supplied.
Suppose the price level decreases from 90 to 75.
Shift the appropriate curve on the graph to show the impact of a decrease in the overall price level on the market for money.
12
Money Supply
10
Money Demand
Money Supply
MD1
2
MD2
10
20
30
40
50
60
MONEY (Billions of dollars)
INTEREST RATE (Percent)
A problem that the Fed faces when it attempts to control the money supply is that
the Fed can only control excess reserves but not total reserves.
the Fed has to get the approval of the U.S. Treasury Department whenever it uses any of its monetary policy tools.
the Fed does not have a tool that it can use to change the money supply by either a small amount or a large amount.
the Fed does not control the amount of money that households choose to hold as deposits in banks.
Chapter 25 Solutions
Principles of Economics (12th Edition)
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- When economists speak of the "zero lower bound problem" that the Fed sometimes faces, what are they referring to? 1. It is when short term interest rates are close to zero meaning the Fed can no longer use changes in interest rates to stimulate the economy 2. It is when economic growth in the economy has reached zero percent and the Fed must use aggressive monetary policy 3. It is when the Fed has sold all the securities on its balance sheet and can no longer impact the money supply using open market operations 4. It is when banks choose to hold no excess reserves, making it impossible for the Fed to lower the discount ratearrow_forwardIf the Fed wishes to increase the money supply, it can: Question 11 options: buy bonds from a bank, giving the bank cash in return, which it can then lend out. sell a bond to bank, and take the money it receives in exchange out of circulation in the economy. buy a bond from a bank, requiring the bank to hold the money it receives as excess reserves. sell a bond to a bank, and take the money it receives and lend it out to someone else.arrow_forwardIf the Federal Reserve wanted to offset a cyclical downturn in overall expenditures, it should sell bonds to decrease the money supply thus increasing the interest rates to decrease business investment and therefore decreasing the overall level of expenditures and decreasing the price level. buy bonds to decrease the money supply thus increasing the interest rates to decrease business investment and therefore decreasing the overall level of expenditures and decreasing the price level. sell bonds to increase the money supply thus decreasing the interest rates to increase business investment and therefore increasing the overall level of expenditures and increasing the price level. buy bonds to increase the money supply thus decreasing the interest rates to increase business investment and therefore increasing the overall level of expenditures and increasing the price level.arrow_forward
- Suppose that the money supply increases by 20 percent. If there is no inflation, what does the quantity theory of money tell us must happen to real GDP? It must increase by more than 20 percent. It must increase by less than 20 percent. It must increase by exactly 20 percent. None of the above are correct. Which of the following statements is true of the federal funds market? No banks are refused loans in the federal funds market. In the federal funds market, banks with a shortage of reserves borrow funds, while banks with an excess of reserves lend them out. The interbank lending system works more efficiently in periods of financial panic than in periods of financial stability. Although the federal funds market aims to provide liquidity to needy banks, it is not very popular as overnight loans are logistically inefficient for large banks. On a graph with real GDP growth on the x-axis and the unemployment rate on the y-axis, you plot each year's values for the United States as…arrow_forwardThe Fed's $2.2 trillion fire hose The Fed threw a lot of money at the financial crisis in 2008 to unfreeze credit markets and encourage economic activity. As part of its effort to keep the interest rate low, the Fed purchased government bonds worth $300 billion between March and September 2009. By October, the Fed held $770 billion in government securities, nearly double its pre-crisis total. Before the crisis, the Fed held mainly government securities, which it used to control the quantity of money in the economy. Now government securities make up just 35% of the Fed's balance sheet. Source: CNN Money, October 9, 2009 If government securities make up just 35 percent of the Fed's assets, calculate the Fed's total assets. What effect did the Fed's purchase of $300 billion of government bonds have on the Fed's total liabilities? If government securities make up 35 percent of the Fed's assets, then the Fed's total assets are $ The Fed's purchase of $300 billion of government bonds…arrow_forwardThe Federal Reserve does not target both the money supply and an interest rate because it would be too confusing to Wall Street and would disrupt the financial markets. it would be too easy for Wall Street to determine what policy the Fed is following and this would destabilize the economy. it would be illegal according to the Federal Reserve Act. the Fed cannot achieve a target for both the money supply and an interest rate at the same time.arrow_forward
- The Federal Reserve manages the amount of money in circulation by buying or selling U.S. Treasury securities, usually Treasury bills. The increase or decrease of money in circulation helps the Fed to control inflation or deflation. This has an effect on your disposable income. Research the Federal Reserve system and money supply, then answer the following questions. Under what conditions would the Fed choose to decrease the money supply, how would it do so, and what is the goal of doing so? How does the Fed factor inflation into its actions?arrow_forwardWhen the Fed targets the amount of money in the economy, interest rates become more variable. True Falsearrow_forwardProblem 4: The hypothetical information in the following table shows what the values for real GDP and the price level will be in 2017 if the Fed does not use monetary policy: Year Potential GDP Real GDP (trillion) Price level (trillion) $17.7 $18.1 2016 2017 a. If the Fed wants to keep real GDP at its potential level in 2017, should it use an expansionary or contractionary policy? Should the Fed buy or sell Treasury bills? 114 $17.7 $17.9 116 b. Suppose the Fed's policy is successful in keeping real GDP at its potential level in 2017. States whether each of the following will be higher or lower if the Fed had taken no action. I. Real GDP II. The inflation rate III. The Unemployment rate c. Draw an aggregate demand and aggregate supply graph to illustrate your answer. Be sure that your graph contains LRAS curves for 2016 and 2017; AD curves for 2016 and 2017; with and without monetary policy action; and equilibrium real GDP and the price level in 2017, with and without policy.arrow_forward
- The fed can sell treasury bills, also known as T-bills. True or falsearrow_forwardIf the Fed wants to increase the money supply by $100 million does it have to buy more than $100 million of bonds, less than $100 million of bonds or exactly $100 million of bonds? Explain.arrow_forwardAccording to the reading, the Fed's mission is to: promote easy access to commodity money. promote maximum employment and stable prices. promote high interest rate for savers. promote an understanding of its role in the economy.arrow_forward
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