End of Chapter Problems

1 a. If a one-year treasury bill has a purchase price of $975,000, its nominal rate of interest is 2.6%, which is found by dividing the
difference between the face value and the purchase price ($1 million - $975,000 = $25,000) by the purchase price ($975,000),
then multiplying by 100.
If the purchase price of a one-year treasury bill falls to $960,000, its nominal rate of interest rises to 4.2%, which is found by
dividing the difference between the face value and the purchase price ($1 million - $960,000 = $40,000) by the purchase price
($960,000), then multiplying by 100.
b. As in any market, a rise in a product's supply reduces its price, while a drop in supply leads to a price rise. Because the
purchase price and nominal rate of interest of treasury bills vary inversely, their nominal rate of interest can be raised if the Bank
of Canada reduces their price through greater supply.
c. In any market, a change in a product's demand affects its price in the same direction. The inverse relationship between the
purchase price and nominal rate of interest of treasury bills means that the nominal rate of interest on treasury bills can be
increased through a decline in price caused by the Bank of Canada reducing its own purchases.

2. a. The Bank of Canada's holdings of government bonds rise by $1 million, an asset of the Bank of Canada. Meanwhile Frontenac
Bank's deposit at the Bank of Canada rises by $1 million, a liability of the Bank of Canada. Frontenac Bank's deposit at the Bank
of Canada rises by $1 million, an asset of Frontenac Bank. Bondholder X's deposit rises by $1 million, a liability of Frontenac
Bank.
b. If the reserve ratio is 5%, Frontenac Bank's actual reserves increase by $1 million while its desired reserves increase by
$50,000. Therefore the Bank's excess reserves increase by $950,000 (= $1 million - $50,000).
c. The maximum effect on the money supply is $20 million. This is found by multiplying the initial change in excess reserves
($950,000) by the money multiplier, which is the reciprocal of the reserve ratio expressed as a decimal [(1 / 0.05) = 20], giving
$19 million, plus the initial $1 million increase in Bondholder X's deposit.

3. a. A $100 million purchase of bonds by the Bank of Canada leads to an immediate $100 million increase in the money supply as
sellers of these bonds deposit payments from the Bank of Canada in their accounts with deposit-takers. Given a reserve ratio of
5%, the actual reserves of deposit-takers have been raised by $100 million while their desired reserves have risen by $5 million
(= 0.05 x $100 million in new deposits). Therefore, deposit takers' excess reserves have risen by $95 million. Through the
process of multiple lending, there is an additional potential increase in the money supply of $1.9 billion [= $95 million x (1 /
0.05)]. As a result, the maximum amount by which the money supply can increase is $2 billion (= $100 million + $1.9 billion).
b. A $50 million sale of bonds by the Bank of Canada leads to an immediate $50 million decrease in the money supply as the
Bank of Canada receives payments from buyers of these bonds and these funds are withdrawn from their accounts with deposit
takers. Given a reserve ratio of 7.5%, the actual reserves of deposit takers have declined by $50 million while their desired
reserves have fallen by $3.75 million (= 0.075 x $50 million in lost deposits). Therefore, CPA members' excess reserves have
declined by $46.25 million. Through the process of multiple lending, there is an additional potential decrease in the money
supply of $616.7 million [= -$46.25 million x (1 / 0.075)]. As a result, the maximum amount by which the money supply can
decrease is $666.7 million [= (-$50 million - $616.7 million)].

4. a. Between 2013 and 2014, the inflation rate has fallen and the unemployment rate has risen. This could have been caused by
contractionary fiscal and/or monetary policies. Between 2014 and 2015, the inflation rate has risen and the unemployment rate
has fallen. This could have been caused by expansionary fiscal and/or monetary policies.
b. Because both the inflation rate and the unemployment rate are higher in 2016 than they were between 2013 and 2015, the
Phillips curve must have shifted to the right. This shift could have been caused by a decrease in the aggregate supply curve with
one possible factor being a drop in labour productivity.
 c.

5. (Essay) When nominal interest rates are rising, the prices of ordinary bonds fall, while a decline in nominal interest rates raises
the prices of ordinary bonds. Because the prices of Canada Savings Bonds stay constant regardless of changes in interest rates, it
is most advantageous to hold Canada Savings Bonds when prices on ordinary bonds are falling due to a rise in nominal interest
rates.

6. (Essay) This statement is true. For example, in the case of an expansionary monetary policy, the Bank of Canada can reduce the
target overnight rate. However, the overnight rate will stay at this new level only if the money supply is increased through the
Bank of Canada's open-market purchases of bonds. In the opposite case, the overnight rate will stay at its new target only if the
supply of money is decreased with open-market sales of bonds.

7. (Essay) In this case, any contractionary moves the Bank of Canada makes to deal with the boom in Saskatchewan's provincial
economy will exacerbate the downturn in spending being experienced in Ontario.

8. (Essay) With a vertical long-run aggregate supply curve, changes in aggregate demand (which cause movements along a given
Phillips curve) lead to alterations in the price level but not in real output. In this case, the Phillips curve must also be vertical in
the long run, since unemployment remains unaffected by variations in aggregate demand.