# M and B

## Quiz 15 :Monetary Control

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What are the Federal Reserve's major assets and liabilities? What are the relative amounts of each?
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Essay

The Federal Reserve's major assets are securities, Loans, other assets. Its major liabilities are monetary base, other current liabilities.
The current (September 2013) relative amounts of assets and liabilities of Fed are as follows: all figures are in billions of dollars.

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Explain how the Fed can increase the money supply by engaging in open-market operations. What role do banks play in this process?
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Essay

Fed can increase the money supply by engaging open market operations. By purchasing government securities, increasing making many more loans to financial institutions such as AIG and Bear Stearns to prevent them from failing. Fed increases the monetary base by increasing the amount of reserves and payment to securities, increasing bank deposit reserves.
The role of banks : The Fed can increase or decrease the monetary base as much as it desires. Changes in the monetary base work their way through the banking system, leading banks to create additional money or destroy existing money. Recall that the money supply is not just the amount of currency outstanding but also includes various deposit accounts at banks. Thus, banks may influence the money supply through their impact on those accounts. The basic idea is that a bank makes a loan that is deposited in other banks, causing increases in the funds on deposit at those banks.

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Defi ne the monetary base, and explain how to use it to analyze changes in the money supply.
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Essay

The sum of currency held by the non-bank public and banks reserves is called the monetary base. In banks' reserves some currency held in banks' vaults and some held on deposit in banks' accounts at the Fed. The term bank means all depositary institutions, including commercial banks, savings banks, savings and loan associations, and credit unions. The Federal Reserve determines it. The Fed controls the money supply mainly by changing the monetary base. Another name for the monetary base is high-powered money.
To know how a change in monetary base affects the money supply, the following formula is used:
Change in money supply = multiplier
Change in monetary base
The symbol
means the change in the variable that follows.

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What decisions do people make that can infl uence the money multiplier and thus the money supply?
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What are the Fed's four tools for affecting the money supply? Which tool is used most commonly?
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Describe the movements in the money multipliers for M1 and M2 over the past 40 years.
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Describe the shape of the supply curve for reserves, and explain why the curve has that shape.

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Describe the shape of the demand curve for reserves, and explain why the curve has that shape.

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What are the maximum and minimum levels that the federal funds rate can reach? What factors determine those levels?
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How do the U.S. Treasury's decisions infl uence the Fed's daily open-market operations?
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Below is the balance sheet of a bank. The reserve requirement is 3 percent on the fi rst $30 million of transactions deposits and 10 percent on transactions deposits in excess of$30 million. The bank holds no required clearing balances. Bank Balance Sheet (amounts in millions of dollars) a Calculate the bank's excess reserves b Suppose that the bank sells $5 million in securities to get new cash. Draw up the bank's balance sheet after this transaction. What are the bank's excess reserves? c Suppose that the bank makes a loan to a customer of an amount equal to the amount of its excess reserves from part b. Draw up the bank's balance sheet before the customer spends the proceeds of the loan. What are the bank's excess reserves? d Now suppose that the customer spends the proceeds of the loan. Draw up the bank's balance sheet, and calculate its excess reserves. Essay Answer: Tags Consider the following balance sheet of Princeton Bank: Balance Sheet for Princeton Bank (amounts in millions of dollars) Of Princeton Bank's reserves,$6 million are required clearing balances held at the Federal Reserve Bank of Philadelphia. Statistics for the economy as a whole are billion billion ratio of currency to transactions deposits ratio of nontransactions deposits to transactions deposits ratio of retail money-market mutual funds to transactions deposits q 0.08 8 percent required reserve ratio on transactions deposits RR/D ratio of required reserves to transactions deposits RCB/D 0.02 2 percent ratio of required clearing balances to transactions deposits a Calculate the monetary base MB , M1, and M2. Are there any excess reserves in Princeton Bank? Are there any excess reserves in the economy as a whole? b Calculate the multipliers for M1 and M2. c Calculate the values of N , D , C , R , MMF , and RCB using the fact that and . d Suppose that the Fed raises the reserve requirement on transactions deposits to 0.18 18 percent. What happens to Princeton Bank's balance sheet? Does it have excess reserves, or is it short of reserves? Calculate the new M1 and M2 multipliers. What happens to MB , M1, M2, N, D, C , MMF , RCB , and R ? e Suppose that instead of raising the reserve requirements as in part c, the Fed sells $150 billion of securities in the open market, including$30 million to a customer of Princeton Bank. What happens to Princeton Bank's balance sheet? Does it have excess reserves, or is it short of reserves? Calculate the new M1 and M2 multipliers. What happens to MB , M1, M2, N, D, C , MMF , RCB , and R ?
Essay
Suppose that the demand for reserves when the federal funds rate exceeds the interest rate on reserves is given by where i is the federal funds rate in percent and D is expressed in billions of dollars. Suppose that the Fed supplies $28.0 billion in nonborrowed reserves and discount loans for business needs are$1.5 billion. Suppose that the primary credit discount rate is currently set at 6 percent and the interest rate on reserves is 2 percent. a Calculate the equilibrium federal funds rate, reserves, and the amount of discount loans for profit. b Suppose that the Fed reduces the supply of nonborrowed reserves to $26.0 billion. Now calculate the equilibrium federal funds rate, reserves, and the amount of discount loans for profit. Essay Answer: Tags Suppose that the Fed's Open-Market Desk thinks that the demand for reserves when the federal funds rate exceeds the interest rate on reserves is given by where i is the federal funds rate in percent and D is expressed in billions of dollars. Suppose that the Fed is currently supplying$29 billion in nonborrowed reserves. Discount loans for business needs are $1 billion. The primary credit discount rate is currently set at 4 percent and the interest rate on reserves is 2 percent. If the Fed's target for the federal funds rate is 3.5 percent, does the Desk need to change the supply of reserves in the market? How much does it need to add or withdraw from the market? After carrying out its daily actions, what will be the equilibrium amount of reserves and discount loans? Essay Answer: Tags Consider a bank that had excess reserves of$3 million, so it made a loan of that amount to a corporation by adding $3 million to the corporation's checking account in exchange for a loan agreement in which the corporation promised to repay the$3 million plus interest over the next three years. If the reserve requirement is 10 percent, how many excess reserves does the bank now have? Should it make another loan to get rid of these excess reserves? Why or why not?
Describe whether each of the following situations represents defensive open-market operations, dynamic open-market operations, or neither. a The Fed purchases $40 billion of securities in the open market on September 11, 2001, when a number of major banks face disruptions in their New York operations. b The Fed reduces the monetary base by$5 billion through open-market sales because infl ation has been rising. c The Fed increases the monetary base by $3 billion because of increased demand by people who want to collect new state quarters. d The Fed raises the discount rate by half a percentage point. e The Fed increases the monetary base by$7 billion because a fi nancial crisis in South America increases the demand for U.S. dollar currency that is shipped abroad.