Econs 201

Econ 201

Homework 7

10 Points Name: _______________________________

1. The Fed is the most independent of all U.S. government agencies. What is the main difference between it and the other government agencies that explains the Fed’s greater independence? (1 point)

2. An article in the New York Times states that “the Bank of japan, the central bank…….is creating money on a vast scale by buying government bonds”.

a. How can a central bank “create money” by buying bonds? Explain (1 point)

3. Identify whether each of the following items is counted in M1 or M2. Fill-in the parenthesis with X to mark your answer. (4 points)

M1 M2

Coins………………………………………………………..$600 ( ) ( )

Savings deposits………………………………………$3,600 ( ) ( )

Travelers checks……………………………………………$60 ( ) ( )

Money Market Mutual Funds…………………..$1,200 ( ) ( )

Checking accounts……………………………………..$560 ( ) ( )

Small denomination time deposits……………..$870 ( ) ( )

Currency……………………………………………………..$800 ( ) ( )

Your Citibank Platinum Master Card with

the credit line……………………………….$5,000 ( ) ( )

A certificate deposit issued

by a New York bank……………………$100,000 ( ) ( )

a. Based on the items you placed into M1 and M2, calculate the size (value) of:

· M1 =

· M2=

b. Refer to your answer about the size (value) of M1 in part a. Assume that the required reserve ratio is 0.2 The Fed wishes to increase the money supply M1 by $800.

All underlying work must be shown.

· What open market operations the Fed would have to take to achieve the stated desired change in the money supply M1?

· How much in government bonds should the Fed sell or buy to achieve the stated desired change in the money supply M1? All underlying work must be shown

· What would be the size (value) of the money supply M1 in the economy as the result of the Fed action?

· What would be the size (value) of the money supply M2 in the economy as the result of the Fed action?

4. Suppose that current money supply is $8,000. The required reserve ratio is 0.5 The Fed wishes to decrease the money supply by $600. Determine the following: (2 points)

All underlying work must be shown

a. What open market operations would the Fed have to take to achieve the stated desired change in the money supply?

b. How much should the Fed buy or sell in the government bonds to achieve the stated desired change in the money supply.

c. What would the money supply in the economy as the result of the Fed action be?

5. What would be the effect on the level of reserves in the banking system and the money supply (M1) of the following monetary policy tools? Fill-in the parenthesis with X to mark you answer.

(2 points)

Reserves Money supply

in the banking system

Increase Decrease Increases Decreases

A .The Fed engages in open market

purchase of government bonds (OMP) ( ) ( ) ( ) ( )

B. The Fed engages in open market

sale of government bonds (OMS) ( ) ( ) ( ) ( )

C. The Fed increases discount rate ( ) ( ) ( ) ( )

D. The Fed decreases discount rate ( ) ( ) ( ) ( )

E. The Fed increases the required

reserve ratio ( r ) ( ) ( ) ( ) ( )

F. The Fed increases the interest rate

on banks reserves ( ) ( ) ( ) ( )

Extra Points ( 5 points)

1. Why did Congress decide to establish the Federal Reserve System in 2013? Briefly explain.

2. What policy tool does the Fed use to control the reserves in banks and the money supply? Which tool is more important?

3. An article in the Wall Street Journal reported in 2015 that the central bank of China, “is freeing up cash by reducing the amount that banks must keep in reserves”.

a. What monetary policy tool was the central bank of China using?

b. In what sense did this policy change ”free up cash”?

c. What was the central bank of China hoping the result of this policy action would be?