What will happen to money demand over time



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MacroEconomics 7


















1. (Federal Reserve System) What are the main powers and responsibilities of the Federal Reserve System? What are its two mandates and some of its other goals? The Fed was to ensure sufficient money and credit in the banking system to support a growing economy. They had the power to issue bank notes, the power to buy and sell securities, and also the power to extend bank loans to member banks.

2. (Subprime Mortgages) What are subprime mortgages, and what role did they play in the financial crisis of 2008? Subprime mortgages are mortgages for a borrower with a not-so-good credit. A subprime mortgage normally had a mortgage broker. Brokers were more concerned about getting their share, so they would lie on loans to approve a borrower. Borrowers stopped making payments on the loans because they could not afford. Housing prices started to plunge led the financial crisis of 2008. Bankers did not want to loan money that they could not get back.

3. (Money Creation) Show how each of the following would initially affect a bank’s assets and liabilities.

a. Someone makes a $10,000 deposit into a checking account. Answer: The bank assets increased $10,000 in cash and liabilities increased by $10,000 in checkable deposits.

b. A bank makes a loan of $1,000 by establishing a checking account for $1,000. The bank has an assets of $1,000 and a liability of $1,000

c. The loan described in part (b) is spent.

d. A bank must write off a loan because the borrower defaults.

4. (Monetary Tools) What tools does the Fed have to pursue monetary policy? Which tool does it use the most?

5. (Monetary Control) Suppose the money supply is currently $500 billion and the Fed wishes to increase it by $100 billion.

a. Given a required reserve ratio of 0.25, what should it do?

b. If it decided to change the money supply by changing the required reserve ratio, what change should it make? Why may the Fed be reluctant to change the reserve requirement?

6. (Money Demand) Suppose that you never carry cash. Your paycheck of $1,000 per month is deposited directly into your checking account, and you spend your money at a constant rate so that at the end of each month your checking account balance is zero.

a. What is your average money balance during the pay period?

b. How would each of the following changes affect your average monthly balance?

I. You are paid $500 twice monthly rather than $1,000 each month.

II. You are uncertain about your total spending each month.

III. You spend a lot at the beginning of the month and a little at the end of the month.

IV. Your monthly income increases.

7. (Market Interest Rate) With a diagram, show how the supply of money and the demand for money determine the rate of interest. Explain the shapes of the supply curve and the demand curve.

8. (Money Supply Versus Interest Rate Targets) Assume that the economy’s real GDP is growing.

a. What will happen to money demand over time?

b. If the Fed leaves the money supply unchanged, what will happen to the interest rate over time?

c. If the Fed changes the money supply to match the change in money demand, what will happen to the interest rate over time?

d. What would be the effect of the policy described in part (c) on the economy’s stability over the business cycle?

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