Question

The Monetary System and Policy

Below represents the monetary system in the US:

Small time deposits

$1,100 billion

Demand deposits and other checkable deposits

$800 billion

Savings deposits

$1,350 billion

Money market mutual funds

$900 billion

Traveler's checks

$30 billion

Large time deposits

$750 billion

Currency

$150 billion

Miscellaneous categories in M2

$40 billion

1. What are the values of M1 and M2?

2. Using the table above, suppose the Federal Reserve requires that all banks maintain a 5%

reserve requirement. If all banks hold no excess reserves, what is the current level of bank

lending?

3. Using the table above, suppose the Federal Reserve requires that all banks maintain a 10%

reserve requirement. If all banks hold $10 billion in excess reserves, what is the current level of

bank lending?

4. From the value of M2 you found in question 1, assume that the price level is 100 and real

output is valued at $218.5 billion. What is the current velocity of money?

5. Continuing from the previous question. The Federal Reserve is currently using the M2 money

supply as a guide to help them in their policy goals. The Federal Reserve wants to promote a

healthy economy. The Federal Reserve, in an attempt to improve the economy, injects $500

billion into the economy over the course of the year. During that same year, real output grew to

$223.83 billion. Based on this, what is the new rate of inflation?

6. Define expansionary and contractionary monetary policy.

7. Based on the above, did the Federal Reserve engage in expansionary or contractionary

monetary policy and how do you know?

8. Suppose the Federal Reserve continues to engage in the operations they carried out in question

5 on a monthly basis, that is injecting $500 billion into the economy every month. What is the

most likely outcome?

Answer 1

Solution

Given data :

Small time deposits = $1,100 billion

Demand deposits and other checkable deposits = $800 billion

Savings deposits = $1,350 billion

Money market mutual funds = $900 billion

Traveler's checks = $30 billion

Large time deposits = $750 billion

Currency = $150 billion

Miscellaneous categories in M2 = $40 billion

Value of M 1 = Traveller's checks + currency + Demand deposits and other checkable deposits

i.e., $(30+150+800) => $980 billion

Value of M 2 =  M1 + Small time deposits + savings deposits + Money market mutual funds + Large time deposits + Miscellaneous categories in M2

i.e., $ (980+1100+1350+900+750+40) => $5120 billion

2.Given that the Reserve requirements is 5% that means it has to maintain 5% of it's total deposits as reserves as mandated by the federal reserve.

Total Deposits (i.e., Net demand and time liabilities) = 5120 * 0.05 i.e., $256 billion

Current level of lending = $4864 Billion

3.Given that the reserve requirement is 10% that means it has to maintain 10% of it's total deposits as reserves as mandated by the federal reserve.

Total Deposits (i.e., Net demand and time liabilities) = 5120 * 0.10 i.e., $512 Billion

Also given that they maintain an excess reserve of $10 Billion.

So,they will be able to lend only the remainder amount i.e., $4598 Billion in the form of loans.

Since the bank does not have any excess reserves,the amount that it will be able to lend is : $4,864 billion

4. Velocity of money = (Price level * Real Output) / (nominal amount of money in supply)

i.e., (100 * 218.50 ) / (5120) => 21850 / 5120 => 4.267

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