NAME___KEY_____________________
ECON 2630: Assignment 3 This assignment is worth 27 points and is due at the start of class on
Wednesday, 8/06. Late assignments will NOT be accepted.
Please staple your assignment prior to turning it in.
1. (2 pts. each).
1a) Bank reserves are 200, the public holds 300 in currency, and the reserve ratio is 0.25. Calculate
deposits and the money supply.
Deposits equal bank reserves/( reserve- ratio) = 200/0.25 = 800.
The money supply equals currency held by the public + deposits = 300 + 800 = 1100.
b) The money supply is 1,250, of which 500 is currency held by the public. Bank reserves are 100.
Calculate the reserve ratio.
Since the money supply equals 1250 and the public holds 500 in currency, bank deposits must
equal 750. If bank reserves are 100, the reserve-deposit ratio equals 100/750 = 0.13.
c) The money supply is initially 2,000 and currency held by the public always equals 200. The reserve
ratio equals 0.40. The Federal Reserve buys an additional 400 in bonds. Calculate the new money
supply.
The money supply will increase by 400/0.40 = 1,000, so the new money supply equals 2,000 +
1,000 = 3,000.
2. (0.5 pts. each) If there is a recessionary gap in the economy, the Federal Reserve will likely
(circle the correct answer) to the following:
Interest rates:
Increase
Decrease
Not change
Money Supply:
Increase
Decrease
Not change
Which will cause (circle the correct answer) to:
Savings:
Increase
Decrease
Not change
Investment:
Increase
Decrease
Not change
Aggregate Demand:
Increase
Decrease
Not change
Aggregate Supply:
Increase
Decrease
Not change
Inflation:
Increase
Decrease
Not change
Unemployment:
Increase
Decrease
Not change
3. Go to the following website: http://www.federalreserve.gov/releases/h6/current/default.htm Use the
seasonally adjusted numbers for M1 and M2 in Table 1 to answer the following questions.
a. (1) What was the total amount in savings accounts in July 2012 and in June 2014.
Savings are given by M2 – M1.
In June 2014 it’s 11351 – 2835 = 8516 ($8.5 trillion)
In July 2012 it’s 10025 – 2322 = 7703 ($7.7 trillion)
b. (1) Calculate the percentage change in M1 and M2 from July 2012 - June 2014.
% Change in M1 = (2835 – 2322)/2322 *100 = 22.1%
% Change in M2 = (11351 – 10025)/10025 *100 = 13.2%
c. (2) From July 2012 – June 2014, average prices have increased by (inflation equals)
approximately 3%. Using concepts discussed in class, briefly explain why inflation is much less
than the percentage changes in M1 and M2.
This relates to the equation of exchange, or that
Price Level * Quantity (Real GDP) = Money Supply * Velocity
There are two reasons why Money Supply can increase but price level does not.
Either Velocity decreases or real GDP increases.
d. (1) In which two months did M1 decline?
M1 declined in November 2012 and in November 2013. This is not too surprising. It is based on
Holiday Shopping (people holding more in cash and withdrawing from checking).
4a. (1) Suppose inflation is 3% and there is an expansionary gap of 2%. According to the Taylor rule,
what should the Federal Funds rate equal?
4 + 2*(0.5) + 3-2*(1.5) = 6.5
4b. (1) Suppose inflation is 0% and there is a recessionary gap of 5%. According to the Taylor
rule, what should the Federal Funds rate equal?
4 - 5*(0.5) - 2-0*(1.5) = -1.5 This is a liquidity trap.
5. The San Francisco Federal Reserve Bank has a “Fed Chairman Game”, where you act as the Fed
Chairman and choose the Federal Funds rate depending on inflation and unemployment. The game can be
found at http://sffed-education.org/chairman/
Your assignment task is simply to play the game. When you are done (your term is up), you will either be
reappointed or dismissed. If you are reappointed, you will receive 10 points. If you are dismissed, you
will receive 0 points.
To prove that you played the game, use the screen capture (Print Screen) function on your computer
(PRTSC or PRTSCN on some keyboards). Paste the image of your completed game – which will state
whether you were ‘reappointed’ or ‘dismissed’ - to a blank Microsoft Word document, and staple it to
your completed assignment when you turn it in. Note that you can play the game as many times as you
please, and you may work with others, but you have to turn in the results from your own game (the same
game results cannot be printed out multiple times or copied). If it is found that you have the same exact
game results (image) as someone else in the class, you both will receive a zero for the assignment.
Your image should look something like this: