Question

Any quantitative questions require showing your work for full credit. Round all $ problems to the nearest cent. All other calculations must be to at least the fifth decimal place. 1) Specifically state what should happen to M1 and M2 (increase, decrease, no change) due to each of the following events. Consider each lettered event to be independent of the others. a) You take the $2,500 out of the shoebox in your closet and use it to pay off your car loan with the bank. b) Higher market interest rates cause the public to move $125b from their checking accounts to their money market deposit accounts. c) Decreased default risk causes banks to have a net increase in their lending of $325b this year. d) The Federal Reserve purchases $22b in U.S. Treasury instruments from commercial banks. e) An individual in the United States receives $25,000 cash (in $100 bills) from a Mexican drug lord for successfully transporting illegal drugs across the border from Mexico to the United States. She deposits the cash into her savings account.

Answer 1

M1 = Cash & currency held by public + Checking account + Demand deposits + Travelers checks + Other checkable deposits

M2 = M1 + Time deposit + Savings deposit + Individual money market deposits

Hence,

(a) Loan Repayment using cash will decrease M1 by $2,500 and decrease M2 by $2,500.

(b) Shift from checking account to money market account will decrease M1 by $125B. But M2 will stay the same.

(c) Increase in lending by banks will increase cash held by public. Both M1 and M2 will increase by $325B.

(d) Fed's purchase of $22B, being an expansionary monetary policy tool, will increase cash held by public. Both M1 and M2 will increase by $22B.

(e) Increase in savings account balance will keep M1 unchanged. But M2 will increase by $25,000.