Study Guide - Money and Banking - Chapter 16-17

Definitions:

money multiplier (m)
monetary base (MB)
required reserve ratio (r_D)
deposit multiplier (DM)
excess reserves

T-F-U, EXPLAIN IN AN ESSAY OF AT LEAST 75 WORDS:

1. If the reserve requirement on demand deposits was set at zero, deposit expansion would approach infinity.
2. The effect of an OMO on the monetary base is always the same.
3. The effect of an OMO on bank reserves is always the same.
4. If the reserve requirement is lowered and the C/D ratio goes up, M1 will increase.
5. The money multiplier, the deposit multiplier and the MS are all inversely related to the required reserve ratio.
6. If the Fed lowers the discount rate and sell treasury securities, the money supply will decrease.
7. If a private individual sells a T-bond to the Fed, cashes the check and takes the proceeds in cash, nothing happens to M1.
8. Without a fractional reserve banking system, the central bank would be unable to use the banking system to conduct monetary policy.

ESSAYS
1. Explain the three tools of monetary policy. Which one is used most often?
2. Explain why independence of the central bank is important.
3. Explain how drug trafficking could affect monetary policy.
4. If Jane Brown closes her checking account and uses the money to buy a five year CD, what happens to M1 and M2? Why?
5. During the Great Depression, the C/D ratio went up and the amount of excess reserves that banks held went up. Predict what would happen to the MS.

PROBLEMS

1. The current MS figures from the latest WSJ are as approximately as follows: (Assume that excess reserves are 0).

M1 = $1075B
C = $465B
R = $47B

a. Calculate the following: Monetary Base, Demand Deposits and Loans & Securities.
b. What are the following ratios: C/D and r_D?
c. Calculate the deposit multiplier and the money multiplier.
d. Analyze the effect of a $5B open market purchase on: Monetary Base, currency, reserves, demand deposits, loans & securities and M1.

2. Assume that the C/D is 10 percent and r_D is 10 percent.  Analyze the effects of a $12B open market operation on M1, D, R, MB, L/S, and C.

3. Current M1 = $325B and D (demand deposits) = $250B. The reserve requirement is 10% on demand deposits and banks hold no excess reserves.
a. what is the current amount of cash, monetary base and loans & securities?
b. analyze the effect of a $20 expansionary open market operation on currency, monetary base, demand deposits, M1, loans & securities, reserves.
c. after the open market operation what is the total amount of M1, currency and demand deposits in the economy?
d. if expansionary monetary policy is fully reflected in a change in the price level, what is the expected rate of inflation caused by the increase in M1?