ECONOMICS 0281

HOMEWORK #2

1. Assume that all banks in the banking system have ER = 0 and that one bank sells \$1,000 of GS to the Fed. If r = 10%, fill in the rest of the table below:

Round        ΔTR            ΔRR         ΔER            ΔLL           ΔDD          ΣΔDD

1         \$1,000.00      \$0.00     \$1000.00    \$1000.00    \$1000.00    \$1000.00

2         \$1,000.00  \$100.00

3

4

5

All
Other
Rounds

Totals

NOTE:             (1) All Other Rounds and Totals categories should be computed only for ΔLL and ΔDD.

(2) Use the multiplier for computing the Totals. Assume c = C/DD = 0 and er = ER/DD = 0.

2. Assume that all banks in the banking system initially have ER = 0 and that one bank sells \$1,000 of GS to the Fed. If r = 10%, the excess reserve ratio er = ER/DD = 10% (banks desire to hold positive ER), and the currency-deposit ratio c = C/DD = 10%, fill in the rest of the table below:

Round     ΔTR       ΔRR       ΔER(1)      ΔER(2)       ΔLL         ΔDD        ΔC           ΣΔDD

1     \$1,000.00    \$0.00    \$1,000.00    \$909.09    \$909.09     \$826.45   \$82.64      \$826.45

2       \$826.45   \$82.64

3

4

5

All
Other
Rounds

Totals

NOTE:             (1) All Other Rounds and Totals categories should be computed only for ΔER(2), ΔLL, ΔDD, and ΔC.

(2) Use the multiplier for computing the Totals. Assume c = C/DD = 0.1 and er = ER/DD = 0.1.

(3) ΔTR = ΔRR + ΔER(1)

(4) ΔER(2) = ΔLL

(5)  ΔLL = ΔER(1)/(1+er)

(6)
ΔLL = ΔDD + ΔC and ΔDD = ΔLL/(1+c)

For example:  \$1,000/1.1 = \$909.09 = ΔLL (Round to nearest cent)

\$909.09/1.1 =  \$826.45 = ΔDD

\$909.09 - \$826.45 = \$82.64 = ΔC

3. Suppose that the following data are available:

r = 12%, c = C/DD = 35%, and er = ER/DD = 3%

TR = \$400B, C = \$100B

a. Compute the MS using the multiplier formula.

b. Suppose that the inflation rate has been increasing and the Fed wants to reduce it by contracting the money supply by 1%. What kind of open market operation must the Fed use and how large must this open market operation be to accomplish its goal? Calculate and explain.

c. Given the situation in part b., suppose that the following also occurs: c decreases to 30% and FDL rise by \$5B. Now what kind of open market operation(s) must the Fed use and how large must it (they) be to accomplish the Fed's goal? Calculate and explain.

d. Compare the Fed's policy actions in parts b. and c. Explain what you observe. Will the Fed always have the information it needs to make the correct decisions? Explain.

4. Use the following data to do the following problems:

The K9 Bank                         The Banking System

DD = \$100,000                          DD = \$100.00M
RR = \$6,250                               RR = \$6.25M
ER = \$2,500                               ER = \$4.00M
FDL = \$10,000                          FDL = \$3.00M
NW = \$25,000                           NW = \$7.00M
GS = \$50,000                             GS = \$75.00M

LL =                                            LL =
TR =                                           TR =

a. Construct T-Accounts for The K9 Bank and The Banking System.

b. Show how The K9 Bank and The Banking System restore lending equilibrium with ER = 0.

5. Using the data from problem #5, do the following:

a. Using the T-Accounts for The K9 Bank and The Banking System from 5.b. (when ER = 0) show what happens when the Fed sells \$5,000 in GS to The K9 Bank. Briefly explain your result.

b. Using the T-Account for The Banking System from 5.b. (when ER = 0) show what happens when the Fed purchases \$5M GS from The Banking System. Briefly explain your result.

6.         Use data below from the Great Depression for the following questions:

a. What was the reserve ratio at the start of the first banking crisis? (HINT: Calculate this figure by using the data below)

er = 0.010

c = 0.167

MB = \$6.5B

MS = \$24.8B

b. Use the data below to calculate the money supply at the end of the final banking crisis in 1933. Explain your results.

r = 0.129

c = 0.340

er = 0.125

MB = \$7B

c. The Fed, noticing that banks ERs were growing very large in 1937, feared that these ERs would be used to create loans and cause an outburst of inflation. So the Fed raised the reserve requirement to wipe out all of the banks ERs. Use the multiplier analysis to explain why the recession of 1937-38 occurred. (Hint: If r = RR/DD rises by the same amount as er = ER/DD falls, then what happens to the multiplier? What must happen for the increase in r to cause a sharp recession?)