Assignment

Topic: Open Market Activity & the Money Supply

Post your responses here by due date. Answer any 5 of the following 7 questions:

Questions:

1) "The Federal Reserve System is structured in such a way as to insulate monetary policy from the political pressures characteristic of the rest of our political system of representative democracy." Do you agree or disagree with this quote? Explain your answer.

2) a) In what sense does the Fed "create money"?

b) Suppose that the minimum required reserve ratio for banks was 1/11. Also suppose that banks held no excess reserves and that currency in circulation was unchanged. What action in the Treasury bill market would the Fed have to take to increase bank checking account deposits by $990 million?

3) Assuming that banks used all their excess reserves to support an increase in the volume of bank lending, by how much would bank lending expand if the Fed undertook the policy action that was your answer to question (2)?

4) Suppose that households in the U.S. increased their desired holdings of currency by $55 million as the Fed was adding reserves to the banking system. How would your answer to question (2) be affected, assuming that the Fed still wished to generate an increase of $990 million in checking account deposits?

5) Suppose that households in the US switched some of their wealth out of their checking accounts and into short term bank CD's. If banks use all excess reserves to support increased lending, what is the effect on this household behavior on the overall volume of bank lending? What is its effect on the level of M1?

6) What is the difference between the Federal Reserve's "discount rate" and the "federal funds" rate? Why is the discount rate in the US not as important in financial markets as the federal funds rate?

7) Why is it not possible for the Fed to predict exactly how large an increase in the money supply (M1) will result from a given open market purchase.