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##### Money Supply Problem-ECON 104 HOMEWORK #8 Assignment

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Question;Part 1: (60 points total)Money Supply ProblemYou are hired by the Chair of the Federal Reserve to manage the trading desk at the New York Fed andthe Chair tells you that he wants you to increase the money supply (M1) by 33 percent. He/she warnsyou to be careful because in these uncertain times, the money multiplier tends to become very unstable.He/she suggests that you stay closely connected with the banking sector and he gives you a list ofphone numbers to do so. Note that in this problem we are targeting the growth rate of M1.Reserve MarketInitial Conditionsrr/D=.10C = 400 bD = 2000 bER = 00 (not a typo)M=C+Da) (6 points) Show your work!i.Calculate the MB.ii.Calculate the money multiplier.iii.What is the money supply (use mm x MB to calculate this)?So you decide to inject $100 billion in reserves via open market purchases with phone in hand. Recall, theChair said to watch that multiplier and so you start making some calls. Just as you suspected, the banksarent making any loans, that is, they are sitting on all $100 billion in excess reserves.b) (6 points) Given these new conditions, redo part a).c) (6 points) Now the Chair calls and asks you how things are going and you tell him/her that youinjected $100 billion in the system but it didnt work. In the space below, write down what youwould say to the chair (i.e., explain why the injection did not work).1Now you get some calls from bankers and you learn that there has been some internal substitution withinthe M1 money supply. In particular, households prefer to hold more currency relative to deposits, i.e., thecurrency to deposit ratio rises. The numbers are as follows:rr/D=.10C = 800 bD = 1600 bER =100 bd) (6 points) redo part a)e) (6 points) Now the Chair is not pleased with your work, and calls again. Assuming that themoney multiplier is now stable (i.e., the value in part d), what must you do, in terms of openmarket operations, to hit the 33 percent money growth rate desired by the chair and the FOMC?Please show all work!f)(10 points) Calculate the total percent change in the monetary base, the money multiplier, and themoney supply (from part a) to part e)) and compare to the actual real world percent changessince this crisis began in August of 2007 to the end of 2010. Please use the following links andclick view data on the upper left to obtain the actual real world values. For the monetary basestart in August 2007 (this is monthly data), for the money multiplier start 8/15/07 (bi-weekly data)and for M1 start at 8/13/2007 (also weekly data)).g) (20 points) Graphing exercise: In the space below, draw two diagrams with a graph of theMonetary Base on the left and the Money Supply on the right. Locate as point A, the conditions thatprevailed in part a), locate as point B, the conditions that prevailed in part b), locate as point C, theconditions that prevailed in part d) and finally, locate as point D, the conditions that prevailed in parte). Helpful hints: don't worry about labeling interest rates, the variable on the vertical axis, since thereare none in this problem. Simply draw vertical lines (as we did in the lecture) labeling the value of theMB and MS on the horizontal axis with the appropriate points (A, B, C, D). If the curve doesn'tchange (hint, this happens with MS but not MB), simply label it with the appropriate A = B orwhichever applies.Part 2: True/ False 40 points total (2 points each)1) If the excess to reserve deposit ratio goes up along with the currency to deposit ratio, all elseconstant, then we are unsure what happens to the money multiplier since the money multiplier isnegatively related to the excess reserve to deposit ratio but positively related to the currency todeposit ratio.2) During each FOMC meeting policymakers discuss the current state of economic affairs in each ofthe 12 regional districts that make up the US. In fact, the Presidents of all the regional FederalReserve Banks attend all FOMC meetings and discuss the conditions in their respective districts.3) If the Fed was worried about overheating (GDP growing too fast, inflationary pressures building),then the appropriate open market operation would be for the Fed to conduct open market sales.24) The FOMC meets in Washington DC but the action, in terms of conducting open marketoperations takes place at the New York Fed (FRBNY).5) During the Great Depression, the excess reserve to deposit ratio rose for a variety of reasons.The impact on the money multiplier was negative. That is, all else constant, a higher excessreserve to deposit ratio lowers the money multiplier.6) In the lectures, we argued that the money (M1) multiplier (since October 2008) has been risinggiven that banks have been hoarding money (due in part to the fact that the Fed is payinginterest on excess reserves) resulting in a rise in their respective reserve to deposit ratios.7) If the money multiplier is 3 and the Fed conducts $100 billion of open market sales, then themoney supply will increase by $300 billion.8) If the money multiplier falls by 50%, then the Fed, to keep the money supply constant, wouldhave to double the monetary base.9) Prior to October 2008, the M1 money multiplier was trending downward since the requiredreserve ratio administered by the Fed was trending upward.10) According to the quantity theory of money in percent change form, then if velocity falls so that itsgrowth rate is negative then the Fed, to keep inflation and output growth stable, should match thedecrease in velocity with an equivalent increase in the percent growth of the money stock.11) According to Milton Friedman, inflation is always and everywhere, caused by excessiveeconomic growth.12) The reason that the existence of money increases efficiency in the economy is that it allowssociety avoid the double coincidence of wants and therefore, allows people to specialize in whatthey do best.13) Assuming that the nominal return on money is equal to zero, the real return to holding money isthe inflation rate.14) The largest component of household sector wealth is wealth in the stock market.15) M2 is more liquid than M1 since M2 includes traveler's checks where M1 does not.16) The FOMC meets every month unless conditions warrant more frequent meetings.17) The Philadelphia Federal Reserve Bank is responsible for monitoring economic activity in theirdistrict which includes the economic activity in State College, PA.18) According to the lecture discussing the October 2012 FOMC statement, the Fed plans on buying$85 billion per month in longer term securities in hopes of lowering long term interest rates.19) According to the lecture discussing the October 2012 FOMC statement, they plan on keepingtheir target for the federal funds rate in the range of 0 -.25% at least through mid 2015.

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