Fall 1999: Homework 5-
Part I:
Problem 1- In doing this problem assume there are no currency drains and that excess reserves equal zero.
(a) The FED sells $2000 worth of T-bills on open market operations. Does the money supply increase or decrease? What will be the total change in the money supply if the required reserve ratio is 20% of demand deposits?
(b) The FED buys $1000 worth of T-bills from a bank in New York. Does the money supply increase or decrease? What will be the total change in the money supply if the required reserve ratio is 20% of demand supply?
(c) Suppose Peter deposits his paycheck of $2000 in a bank in Madison. What will be the total change in money supply if the required reserve ratio is 20% of demand deposits?
Problem 2- Consider an economy where the required reserve ratio is 30% of demand deposits. Suppose, Anne sells $1000 worth of government securities to the FED and deposits the proceeds ($1000) into Madison First Bank. (Again, assume no currency drains).
(a) Assuming that all accounts were initially in balance, draw the change in Madison First Bank's balance sheet after Anne makes her deposit. Be sure to clearly label all entries.
(b) Suppose now, that Madison First Bank lends out any excess reserves to Kate who uses the entire loan to pay for a new Home Theatre System in Movies, inc. She pays with a check and Movies, inc. deposits it at Wisconsin State Bank. Clearly indicate how would these transactions be registered at the Madison First Bank and Wisconsin State Bank balance sheets.
(c) Now suppose that Wisconsin State Bank lends out all of its excess reserves to Paul. Paul deposits this loan at Bank Mendota and so on. How would the balance sheet look like for all banks combined, after this lending cycle has taken place many times.
Problem 3- Consider the following economy:
Money market: Md = 4000 - 200r
Ms = 2000
Output or goods market: C = 1000 + 0.75(DI) - 20 P
I = 2500 - 30r
G = 2000
T = 1000
DI = Y - T
Where P is price and r is the interest rate.
(a) Find the equilibrium interest rate.
(b) Using your answer in part (a) and assuming P = 30, find the equilibrium level of output (Ye). (Hint: This is a Keynesian model where the price level is fixed).
Now suppose aggregate demand (AD) and aggregate supply (AS) are given by:
AD: Y = C + I + G
AS: Y = 120P
(c) Find the aggregate demand equation that relates output to prices. Use your answer in part (a). (Hint: Think of a normal demand equation relating prices and quantities).
(d) Find the equilibrium level of output and prices. (Hint: Use your results in part (a) and (c).)
(e) Suppose full employment GDP is 10800. Does the current equilibrium GDP show an inflationary gap?
(f) The government decides to modify its level of purchases in order to reach full employment GDP (i.e. YFE = 10800).
i. What will be the new level of government purchases?
ii. Does the equilibrium price increase or decrease? Why? (Hint: Don't use multipliers).
(g) Suppose now, that the Federal Reserve increases the money supply (Ms) to 2334 (and G = 2000). What is the new interest rate? Can we reach the full employment GDP (i.e. YFE = 10800)?
Part II:
Read an article from an economic or financial publication that has relevance for what we are learning in this class. The "accepted" list of publications is Wall Street Journal, Financial Times, The Economist, Barron's and Business Week. Obviously, this list is not intended to be comprehensive. If you find a good and interesting article in any publication, printed or on the Internet, you are invited to read it.
Write one page (single spaced, font 10) review of the article you just read. Attach a copy of the original article.
Your review will be graded according to its relevance for this class, the ideas you put forward, and your knowledge of written English.