Chapter 3 Recommended End-of-Chapter Problems and Solutions
1.
What would happen to the monetary base if the U.S. Treasury collected $4 billion in
taxes, which it deposited in its account at the Fed, and the Fed bought $3.5 billion in government
securities? What effect might this have on the Fed Funds rate?
The first transaction would lower bank reserves and increase Treasury deposits at the Fed by $4
billion. The second transaction would restore $3.5 billion in bank reserves. The net reduction of $0.5
billion in reserves might only put the smallest upward pressure on the Fed Funds rate. This is why, to
keep the Fed Funds rate on target, the FOMC cannot ignore large Treasury transactions when formulating
open market operations.
2.
If the Fed bought $3.5 billion in government securities and the public withdrew $2.0
billion from their transactions deposits in the form of cash, by how much would the monetary base
change? By how much would financial institutions' reserves change? By how much would financial
institutions' required reserves change if all proceeds from bond sales and all withdrawals from
transactions accounts were deposited in or taken from accounts subject to a 10 percent reserve
requirement? By how much would depository institutions' net excess reserves change?
The open market purchase increases the depository institution deposits at the Fed by $3.5 billion.
The cash withdrawals, coming from vault cash, have no effect on depository institution deposits at the
Fed. However, they cause reserves in the banking system to come down by $2 billion. Since Federal
Reserve Notes outstanding remains the same, the net effect of the monetary base is +$3.5 billion. But the
net effect on reserves in the banking system is +$1.5 billion. After allocating $150 million to required
reserves, the banking system would then seek to lend or invest immediately $1.35 billion of excess
reserves.
5.
What is the essential difference between the Keynesian and the Monetarist view of
how money affects the economy?
Monetarists believe the key financial variable for changing economic activity is the money
supply. They assume that propensity to consume rises or drops as people perceive they have “more” or
“less” money. Thus the money supply can be used to influence aggregate demand. To monetarists,
short-term interest rates merely indicate monetary policy’s effects.
Keynesians believe the key financial variable is interest rates: Real sector economic growth is
stimulated by falling rates as economic activity costs less to finance, or lowed by rising rates as economic
activity costs more to finance. To Keynesians, money supply changes reflect reactions to interest rates
•
Consider an economy whose money supply is $200 billion. If the velocity of money
is 9.5, what is the economy’s GDP?
9.5(200) = $1.9 trillion
•
For simplicity, we have been assuming that Currency and Federal Reserve Notes (on
the Fed balance sheet) were the same thing. Actually, Currency is Federal Reserve Notes + coin,
and the amount of US coin currently in circulation is $50 billion. Therefore, in billions, if Federal
Reserve Notes = 1,342, savings accounts = 960, depository inst balances = 2,753, and checking
accounts = 1,708, what are currency, the monetary base, and M1?
Currency
= 1,342 + 50
= 1,392
Monetary base = 1,342 + 2,753 = 4,095
M1
= 1,392 + 1,708 = 3,090
If a $2 billion securitization pool has outstanding $200 million in CP, $1.2 billion in senior
securities, $360 million in mezzanine securities, and $240 million in equity securities, upon which it
pays 1.5%, 3.0%, 5.0% and 7.0%, respectively, in yearly interest, what is the pool’s average rate of
interest?
.10(1.5) + .60(3.0) + .18(5.0) +.12 (7.0) = 3.69%
If a bank charges 12.5 basis points per annum (365-day year) for a backup line of credit, how much
is this on $2 billion of 30-day CP?
.00125(30/365)($2 billion) = $205,479.50
Let k = 12.5%. Assume a banking system with 400 in transaction deposits that is all
loaned/invested up. Suppose the central bank injects 10 into the system and that the system again
becomes loaned/invested up. With slide 22 of Module 2.3 in mind, what would be the entries in all
three T-accounts for this example (to nearest integer)?
Top T-account
50
350
400
Middle T-account
60
340
400
Bottom T-account
60
420
480