CALIFORNIA STATE UNIVERSITY, SACRAMENTO
Department of Economics
Prof. A. R. Gutowsky
Economics 1A
Problem Set 4
Chapter 13
1. What is money?
(A) Money performs what functions?
2. Bank’s managing their asset/liability portfolio need to balance profit versus
safety. Explain.
3. Money Creation: A Single Bank
(A) Know the meaning of the following terms:
reserve ratio (or requirement), excess reserves, reserve test,
primary
deposit, derivative deposit, external clearing drain, bank credit, fractional reserve
banking system
(B) Why can a commercial bank only create money
equal to its excess reserves?
(1) You need to understand the t-accounts found on pages 246-247.
(2) Given the following individual commercial bank balance sheet:
Reserves 100
Deposits 500
Loans 300
Investments 100
Reserve Ratio = .20
(A) Can this bank create any (more) money? Explain.
(B) The bank experiences a primary deposit of $ 10. What will happen to the above balance
sheet?
(1) Can the bank create (any more) money? Explain.
(2) What will happen to the balance sheet when the bank creates money?
Note: a derivative deposit is created
(3) What will happen to the balance sheet given the external clearing drain?
(4) Does the bank meet the "reserve test?"
(C) Change the reserve ratio to .15, can this bank create any (more) money? Explain.
(1) What will happen to the balance sheet when the bank creates money?
Note: a derivative deposit is created
(2) What will happen to the balance sheet given the external clearing drain?
(3) Does the bank meet the "reserve test?"
4. Money Creation: A Commercial Banking System
(A) Why can a
commercial banking system create additional money by a multiplier of its excess reserves
while an individual commercial bank can only create additional money equal to its excess
reserves?
(1) You need to understand the t-accounts found on pages 248-250. Note: the money creation
process
is comparable to that of "multiplier" where there were rounds of induced
spending each round
smaller than the one before.
(2) Given the following commercial banking system balance sheet:
Reserves 100 Deposits
500
Loans 300
Investments 100 Reserve Ratio = .20
(A) Can this commercial banking system create any (more) money? Explain.
(B) Is the commercial banking system meeting the reserve test?
(C) Change the reserve ratio to .15, can this commercial banking system create
any (more) money? Explain.
(1) What will happen to the balance sheet when the banking system creates money?
Note: a derivative deposit is created
(2) What will happen to the above balance sheet given the external clearing drain?
(3) Does the bank meet the "reserve test?"
(D) Repeat the above question but assume the reserve ration is .25.
(1) What does this commercial banking system need to do to meet the reserve test?
Be specific.
Chapter 14
1. What is the difference between money and income?
2. What is the "FED?" Open Market Committee? Board of Governors?
(A) What do you know about the
"independence of the FED?"
(B) Why was the FED created?
3. How does the FED control the money supply and influence the rate of interest?
(A) What is an open market operation?
(B) Know the balance sheet found on page 261.
(C) Given the following FED balance sheet:
Loans
20 Deposits:
Securities 100
Commercial Banks 120
and the following commercial banking system balance sheet:
Reserves 100
Deposits 500
Loans 300
Investments 100
Reserve Ratio = .20
(1) The FED purchases $ 10 of U.S. Government Securities from the commercial banking
system.
What will happen to the above balance sheets?
(2) Repeat the above question for an open market sale of $ 5.
(D) Explain how an open market sale will affect
bond prices and interest rates?
(1) What is the Federal Fund Rate?
4. What other instruments of monetary control does the FED possess?
(A) What is the discount rate?
(B) How are reserve requirements used as an
instrument of monetary control?
(C) How does the FED use each of the above
instruments to influence the banking system and the money market?
5. Determination of the Rate of Interest
(A) What is meant by the money supply
mechanism?
(B) What are the determinants of the demand for
money?
(1) Why is the demand schedule for money downward sloped?
6. The Monetary Mechanism
(A) How does the FED influence the money
supply, bank credit, the rate of interest, spending, output (GDP),
employment,
unemployment, the price level and the rate of inflation?
(1) To answer this question you need to know the material found on pages 268-271.
(B) The economy is experiencing a recessionary
gap. What kind of monetary policy should the FED initiated?
Is it
restrictive or easy?
(1) How will the FED implement such a policy?
Open market
sales or purchases
Discount rate
increases or decreases
Reserve requirements increased or decreased
(2) What will happen to the
Money supply
increase or decrease
Interest rate
Bank credit
(3) What will happen to:
Consumption
Investment
Demand
Output (GDP)
Employment
Unemployment
Price Level
Rate of Inflation
(4) Use AD/AS analysis to illustrate your answers.
(D) Repeat the above question for an
inflationary gap.