Economics 304 Homework - Lesson 7 - The Fed and the Money Supply Correct Answers - Solved Assignments | Economics

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1Economics 304 Homework-Lesson 7-The Fed and the Money SupplyCorrect Answers90 points total:Instructions:Please show all work or points will be taken off. Good luck!1. (35 points total) In this problem, we are going to calculate the moneymultiplier oneyear prior to the Great Recession (12/2006) and compare it to the money multiplier fiveyears hence (12/2011).The implication as you may have guessed is that since the Fedhas been paying interest on excess reserves (10/2008), the excess reserve to deposit ratiohas risen which implies a lower money multiplier.1To do so, wewill use the datafrom FRED (Federal Reserve Economic Data).Note, after clicking on hyperlink, lookto the upper left and click on "view data" to retrieve the data that you need to do theproblem.To make sure we are on the 'same page,'the amount of excess reserves inDecember, 2006 is $1.862 billion (we are using beginning of month data).Data you need forproblem 1:Monetary Base2006-12-01837.7012011-12-012603.613Excess Reserves12/06 1.86212/111502.318Currency2006-12-01749.52011-12-01999.8Required Reserves2006-12-0141.4202011-12-0196.514Demand Deposits2006-12-01610.8

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22011-12-011164.6a)(10 points)Calculate the money multiplier for Dec 2006, one year prior to the GreatRecession. Please show all work.b)(10 points)Calculate the money multiplier for Dec 2011, five years hence and a littlemore than three years after the Fed got the authority to pay interest on excess reserves.ClickHerefor the press release.c)(5points)What is the percent change in the money multiplier in this five year period?d)(10points)Now consider the change in the monetary base during this same five yearperiod and compare it to the change in excess reserves.Is it a true statement to say mostof the open market purchases that caused the monetary base to "blow up" ended up onbank's balance sheets as excess reserves.Be very specific with your answer using actualnumbers. Which change is bigger and why??2.(35 points total)You are the director of monetary affairs at the Fed and you are incharge of keeping track of the money supply, making sure it does not fall, as it did in theGreat Depression, but also making sure it does not ‘blow up’ as we know it might,knowing that the banks are sitting on piles and piles of excess reserves (see pic below).You have the following initial conditions:RR/D= .10

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3C =400 bD =1000bER =500 ba) (6points)i) Calculate the MB.ii) Calculate the money multiplier.iii) What is the money supply (use mm x MB to calculate this)?Show workNowyou know that if these banks get rid of their excess reserves all at once, the amount of open marketsales that you need to conduct (to keep a handle on the money supply) will be massive and raise more thanone eyebrow in Washington (from the politicians) as the infamous ‘exit strategy’ will be full speed ahead.The Fed’s treasured independence would be tested once again and you want to avoid that.Suppose thatyou had major influence and convinced the banks that it would be much more stabilizing forall parties ifthey gradually lent out their excess reserves rather than lending them out all at once.As such, youconvince the banks to cut (lower) their excess reserve to deposit ratio in half (note: the ER/D ratio is cut inhalf not ER itself).Assuming importantly that:•The C/D and RR/D remain the same as in the initial conditions (they are stable)•The monetary base does not changeb) (4 points) Repeat part a) except for part i).c) (5 points) Given that 10% is the optimal growth rate of the money supply (from its initial value in parta), what type and how many open market operations do you need to conduct to achieve this target, givenwhat happened to the money supply in part b)?Assume importantly that the money multiplier is stable atits new level (after the banks cut E/D in half, i.e., part b).We now pretend that this crisis is well behind us and now it is time to go back to targeting the funds rate.You are facing the following conditions:Reserve MarketInitial Conditionsrr/D= .10C= 200 bD =1000bER =00M = C + Dd)(5points)If Rd=400–100iff, given the information above, what is the market clearing federalfunds rate?This happens to be the fed funds target.Show work.e) (5 points) Suppose two things happen simultaneously:1) reserve demand is increasing and is nowexpected to be:Rd=500-100iffand 2) Chairman Bernanke calls you up and wants you to increase thefunds rate by 150 basis points (one and one half percentage points) beyond its equilibrium value in part d).What type and how many open market operations must you conduct to satisfy Chairman Bernanke?Showall work.

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