money-and-banking-practice-question

Unless otherwise noted, the following assumptions are made in all of the applied problems: the required reserve ratio on checkable deposits is 10%, banks do not hold any excess reserves, and the public’s holdings of currency do not change.

Q17. If the Fed sells $2 million of bonds to Irving the Investor, who pays for the bonds with abriefcase filled with currency, what happens to reserves and the monetary base? Use Taccountsto explain your answer.

Q19. Using T-accounts, show what happens to checkable deposits in the banking system when theFed lends $1 million to the First National Bank.

Q21. If the Fed buys $1 million of bonds from the First National Bank, but an additional 10% ofany deposit is held as excess reserves, what is the total increase in checkable deposits? (Hint: Use T-accounts to show what happens at each step of the multiple expansion process.)

Q25. Suppose that currency in circulation is $600 billion, the amount of checkable deposits is$900 billion, and excess reserves are $15 billion.

a. Calculate the money supply, the currency deposit ratio, the excess reserve ratio, and themoney multiplier.

b. Suppose the central bank conducts an unusually large open market purchase of bondsheld by banks of $1400 billion due to a sharp contraction in the economy. Assuming theratios you calculated in part (a) remain the same, predict the effect on the money supply.

c. Suppose the central bank conducts the same open market purchase as in part (b), exceptthat banks choose to hold all of these proceeds as excess reserves rather than loan themout, due to fear of a financial crisis. Assuming that currency and deposits remain thesame, what happens to the amount of excess reserves, the excess reserve ratio, the moneysupply, and the money multiplier?

d. During the financial crisis in 2008, the Federal Reserve began injecting the bankingsystem with massive amounts of liquidity, and at the same time, very little lendingoccurred. As a result, the M1 money multiplier was below 1 for most of the time fromOctober 2008 through 2011. How does this scenario relate to your answer to part (c)?

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