Question

4. The combined balance sheet of all the commercial banks in the economy is as follows: a. What is the reserve ratio? b. The economy is in a recession, so the fed will engage in [expansionary/contractionary] monetary policy to [increase/decrease] AD. The Fed will [sell/buy] $20 billion worth of bonds from the banks. What will reserves be after this transaction? c. By how much would the money supply increase if the banks fully utilized their lending capacity and all money lent was redeposited into the banking system? 5. Suppose the Fed decided to sell $60 billion worth of government securities on the open market. a. If the reserve ratio is 5%, what is the maximum potential change in the money supply? Will the money supply increase or decrease? b. What will this sale by the Fed do to interest rates? Why? c. Under what circumstances would the Fed be pursuing such an open market policy? 6. To obtain the same objectives in 45 , should the Fed increase or decrease a. the discount rate? b. the IORB?

Answer 1

4)

a. What is the reserve ratio?

The reserve ratio is the ratio of reserves held by commercial banks to their total deposits.

b. What will reserves be after this transaction?

The Fed will engage in contractionary monetary policy to decrease AD. The Fed will sell $20 billion worth of bonds from the banks. After this transaction, reserves will decrease by $20 billion.

c. By how much would the money supply increase if the banks fully utilized their lending capacity and all money lent was redeposited into the banking system?

The money supply would increase by $20 billion if the banks fully utilized their lending capacity and all money lent was redeposited into the banking system.

5)

a. If the reserve ratio is 5%, what is the maximum potential change in the money supply? Will the money supply increase or decrease?

If the reserve ratio is 5%, then the maximum potential change in the money supply is $60 billion. The money supply would increase.

b. What will this sale by the Fed do to interest rates? Why?

The sale by the Fed would decrease interest rates. This is because the sale of government securities decreases the amount of money available in the market, which in turn decreases the demand for money, causing the interest rate to decrease.

c. Under what circumstances would the Fed be pursuing such an open market policy?

The Fed would be pursuing this open market policy if it wanted to increase the money supply in order to decrease interest rates and stimulate economic growth.

6)

a. the discount rate?

The Fed should decrease the discount rate to obtain the same objectives in 45.

b. the IORB?

The Fed should increase the IORB to obtain the same objectives in 45.

The discount rate is the interest rate charged to commercial banks when they borrow from the Fed's discount window. The discount rate is often used by the Fed to control the money supply. By decreasing the discount rate, the Fed can make it cheaper for banks to borrow money, which encourages banks to lend more, increasing the money supply.

The IORB, or Interest on Required Balances, is the interest rate that commercial banks receive when they keep a certain amount of their balances at the Federal Reserve Bank. By increasing the IORB, the Fed can make it more lucrative for banks to keep a certain amount of their balances at the Federal Reserve Bank, which increases the amount of money held by the Fed and decreases the money supply.