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faria001) ECO 2013 Assignment 13 (13+14)
1. a. Reserves provide the Fed a means of controlling the money supply. It is through increasing and decreasing excess reserves that the Fed is able to achieve a money supply of the size it thinks best for the economy. b. Reserves are assets of commercial banks because these funds are cash belonging to them; they are a claim the commercial banks have against the Federal Reserve Bank. c. Reserves deposited at the Fed are a liability to the Fed because they are funds it owes; they are claims that commercial Banks have against it. d. Excess reserves are the amount by which actual reserves exceed required reserves. e. Excess reserves equal the actual reserves minus the required reserves. Commercial banks can safely lend excess reserves, thereby increasing the money supply. 2. The most common mechanism used to measure this increase in the money supply is typically called the money multiplier. It calculates the maximum amount of money that an initial deposit can be expanded to with a given reserve ratio. The money multiplier, m, is the inverse of the reserve requirement, R (the reserve ratio).
3. a. i. The basic determinant of the Transactions Demand for Money is Nominal GDP. The level of nominal GDP: The higher this level, the greater the amount of money demanded for transactions. ii. The basic determinant of the Asset Demand for Money is the interest rate: The higher the interest rate, the smaller the amount of money demanded as an asset. b. The equilibrium interest rate is determined at the intersection of the total demand for money curve and the supply of money curve. c. As interest rate decreases the demand for money increases the true is the same for vice versa. 4.
The Discount Rate is the interest rate the Fed offers to member banks and thrifts who need to borrow money to avoid having their reserves dip below the required minimum. The higher the discount rate, the higher mortgage interest rates will be. When the discount rate goes up, the prime rate goes up as well, which slows the demand for new loans, and cools the housing market. The opposite is also true. If the fed lowers the discount rate, the prime rate will come down, and mortgage interest rates will dip to more favorable levels. Prime Rate is the interest rate offered by commercial banks to its most valued corporate customers.
a. Cyclical asymmetry refers to the condition where a tight monetary policy is relatively potent at contracting economic activity, while an easy money policy is relatively weak at stimulating an economy. The weakness in easy money policy results when, even though the Fed increases liquidity (reserves) in the system, potential borrowers are unwilling to spend (often because of uncertainty over general weakness in the economy). b. If pursued vigorously, a tight money policy could deplete commercial banking reserves to the point where banks were forced to reduce the volume of loans. The Fed can turn down the monetary spigot and eventually achieve its goal. The Fed can create excess reserves, but it cannot guarantee that the banks will actually make the loans and thus increase the supply of money. If commercial banks, seeking liquidity, are unwilling to lend, the efforts of the Fed will be of little avail. Furthermore, a severe recession may so undermine business confidence that the investment demand curve shifts to the left and frustrates an easy money policy. c. Yes the Federal Reserve Lowers Interest Rates again and the current mortgage interest rates have risen.