Question

number two pls. parts a-e

PROBLEMS AND APPLIUA Fed flies a helicopter over 5" Aven New York City and drops newly printed $100 bills. 1. What are the three functions of money? Which of the functions do the following items satisfy? Which do they not satisfy? a. A credit card b. A painting by Rembrandt c. A subway token 2. Explain how each of the following events affects the monetary base, the money multiplier, and the money supply. a. The Federal Reserve buys bonds in an open- market operation. b. The Fed increases the interest rate it pays banks for holding reserves. c. The Fed reduces its lending to banks through its Term Auction Facility. d. Rumors about a computer virus attack on ATM machines increase the amount of money people hold as currency rather than demand deposits. 3. An economy has a monetary base of 1.00 bills. Calculate the money supply in scenarios (a)-(d) and then answer part (e). a. All money is held as currency. b. All money is held as demand deposits. Banks hold 100 percent of deposits as reserves. c. All money is held as demand deposits. Banks hold 20 percent of deposits as reserves. d. People hold equal amounts of currency and demand deposits. Banks hold 20 percent of deposits as reserves. e. The central bank decides to increase the money supply by 10 percent. In each of to above four scenarios, how much should increase the monetary base?

Answer 1

2.

a.

When Fed buys the bond, the dollar value it pays to the public increase the monetary base.

The money supply would also incraese due to increase in cash-in-hand as Fed pays dollar value to the public while purchasing the bonds from them.

The money multiplier would be affected depending on the currency-deposit ratio and reserve-deposit ratio.

b.

When Fed increases the interest rate that it pays to the bank for holding reserves, the banks increase their reserves holding, thereby resulting in increase in reserve-deposit ratio. This will decrease the money multiplier. This will further decrease the money supply.

However, the monetary base would increase as banks are holding greater reserves

c,

Fed when reduce lending to banks through term auction facility, it increases the liquidity in US credit market. Thus, the monetary base falls. This in turn reduce the money supply.

The money multiplier is not affected as this action is not likely to affect the currency-deposit or reserves-deposit ratio.

d.

If there are rumours, consumer would lose confidence in ATM, increased money in form of cash-in-hand rather than demand deposits would lead to lowering of reserves with the bank in the form of deposits.

The monetary base would remain unaffected.

The money supply would fall due to increased cash-in-hand to demand deposit ratio.

e.

When Fed drops newly printed money from a helicopter, this will increase the monetary base and money supply. If any of these printed money ends up with the bank, the money supply would increase by the multiplier effect due to loan-creation activity of the bank. If these printed money end up with people and are held in cash in hand, the money multiplier would fall due to increased ratio of cash-in-hand to demand deposit ratio.