25
Answers Chapter to End-of-Chapter Problems and Applications
2. As the Chinese government was being defeated, Chinese paper currency was ceasing to be fiat money, but, at least in Japan, had become a commodity money.
4. There is no effect on M1 because both currency and checking account balances are included in that measure of the money supply. Because M1 is not affected, neither is M2.
6. Deposits. Having more deposits allows these banks to make loans and other investments on which they are able to make profits.
8. There is no impact. The $100 was part of M1 when it was in your checking account and is still part of M1 when you hold it as currency.
10. Yes. The statement is correct. When bank reserves increases, they increase their loans, which creates new checking account deposits, thereby expanding the money supply.
12. a.
Bank of America
Assets
Liabilities
Reserves
+$2,000
Deposits
+$2,000
228
Money, Banks, and the Federal Reserve System 229
b.
Bank of America
Assets Liabilities
Reserves Loans
+$2,000 +$1,600
Deposits Deposits
+$2,000 +$1,600
c.
Bank of America
Assets Liabilities
Reserves Loans
+$400 +$1,600
Deposits
+$2,000
Citibank Bank
Assets Liabilities
Reserves
+$1,600
Deposits
+$1,600
230 Chapter 13
d. Change in checking account deposits = $2,000 x
1 = $2,000 x 5 = $10,000 0.20
Because checking account deposits are part of the money supply, it is tempting to say that the money supply has also increased by $10,000. But remember that your $2,000 in currency was counted as part of the money supply while you had it, but is not included when it is sitting in a bank vault. Therefore, Change in the money supply = Increase in checking account deposits Decline in currency in circulation = $10,000 $2,000 = $8,000.
14. a.
FNB
Assets Liabilities
Reserves
+$10 million
Discount Loan +$10 million
b. $10 million c. Change in checking account deposits = $10 million x
1 = $100 million. 0.10
16. a. b.
Price deflation occurs when the price level declines from one year to the next.
Ordinarily, as the quantity theory of money indicates, assuming velocity does not decline, rapid
increases in the money supply lead to inflation. c. If consumers believe that prices are falling, they may postpone purchases because they expect prices to be lower in the future. This decline in consumption may push the economy into recession.
18. Banks do not print money, but they create money, specifically checking account balances, when making loans from excess reserves. By creating loans, banks create checking account balances.
20. The large quantity of Confederate dollars would have generated high inflation, which would have decreased the value of the Confederate currency. With the war drawing to an end, Southerners would
Money, Banks, and the Federal Reserve System 231
have been less and less willing to accept Confederate dollars. They could have made barter exchanges, or used dollars issued by the federal government of the United States.
Chapter 26
Answers to End-of-Chapter Problems and Applications
2.
To speed the recovery from the 2001 recession, the Federal Reserve pursued an expansionary
monetary policy by lowering the target for the federal funds rate. The lower interest rates sustained and boosted the housing market even with the economy in recession.
4. a. Its original level must have been 1.75% + 4.75% = 6.5% b. As shown in Figure 14-4, an increase in the money supply will reduce interest rates.
6. The higher the interest rate, the more willing banks will be to make loans, everything else equal. The more loans banks make, the more money that is created. Therefore, there is good reason to think of the money supply curve as upward sloping.
With an upward sloping money supply curve, an increase in the demand for money will cause both the equilibrium interest rate and the equilibrium level of M1 to increase.
232 Chapter 13
8. The author of the editorial confused the federal funds rate with the discount rate. The discount rate is the interest rate at which the Federal Reserve lends money to commercial banks.
10. Apparently banks in Japan were not lending out the new reserves being created by the Bank of Japan's expansionary monetary policy. For an expansionary monetary policy to be successful, banks have to lend out the reserves created by the central bank. Banks in Japan were having difficulty finding firms optimistic enough about the future to be willing to borrow in order to purchase new machinery, equipment, and buildings.
12. If the main economic problem is inflation, a central bank will keep interest rates high and the rate of growth of the money supply low. If the main economic problem is slow growth and unemployment, a central bank will keep interest rates low and the rate of growth of the money supply high.
14. a. Real GDP will be $12.6 trillion and the price level will be 109.0 b. The Fed should pursue a contractionary policy and the trading desk should sell Treasury bills. c. Without contractionary monetary policy, the inflation rate in 2008 =
109.0 - 104.7 100 = 4.1%. 104.7
With contractionary monetary policy, the inflation rate in 2008 =
107.0 - 104.7 100 = 2.2%. 104.7
16. The statement is incorrect. An increase in the money supply does not affect real GDP directly, and certainly not dollar-for-dollar. An increase in the money supply increases real GDP by lowering interest rates, which in turn increases spending. When interest rates are lower, households are more likely to buy new homes and automobiles and firms are more likely to buy new factories and computers. Lower interest rates also lead to a lower value of the dollar, which lowers the prices of exports and raises the prices of imports, thereby increasing net exports.
Money, Banks, and the Federal Reserve System 233
18. Policymakers at the Fed believe that although it is not perfect, active monetary policy is still able to play an important role in stabilizing the economy. Further, the monetary growth rule proposed by Friedman has its own problems, since the relationship between money growth and real GDP and the price level has weakened.
20. On the surface, the statement is incomplete. Any factor that causes aggregate demand to grow faster than aggregate supply, or causes aggregate supply to decrease will generate inflation. But, budget deficits (government spending more than it takes in) often lead, especially in the developing world, to the central bank purchasing the government bonds issued to finance the budget deficits. Purchases of government bonds by the central bank increase the money supply, which causes inflation.
Chapter 27
Answers to End-of-Chapter Problems and Applications
2. Keynes is discussing the multiplier effect. By repercussions, he means the rounds of spending and new production set off by an initial increase in autonomous expenditures. Keynes believed that the government purchases multiplier was about 10. Therefore, even wasteful government spending would result in a substantial increase in the production of goods and services and in employment.
4. Balancing the federal government's budget in 1932 was not a good idea because the economy was in the midst of the Great Depression. Increasing taxes and cutting government purchases would reduce aggregate expenditures and further reduce real GDP.
6. The remark is half right. With a multiplier of 2, an increase of $125 billion in government spending will increase real GDP by $250 billion. But the multiplier does not apply to increases in the money supply.
8. As the demand for money increases, with the supply of money constant, households and businesses sell Treasury bills as they try to increase their holdings of cash. The increased supply of Treasury bills lowers their price and increases the interest rate.
234 Chapter 13
10. Monetary policy is used more often than fiscal policy, which is why Alan Greenspan rather than President Bush and Congress is often referred to as steering the economy.
12. When tax revenues are not sufficient to pay the federal government's bills, the Treasury borrows the necessary funds. The Treasury is repaying the investors who had bought its bonds. The Treasury thought the federal budget would be in surplus, but it ended up in deficit.
14. As a budget surplus develops during a recovery but before the full employment level of real GDP is attained taxes are greater than government expenditures. Rising taxes reduce the ability of consumers and businesses to increase their spending. The federal government could have increased government purchases or cut taxes in order to avoid letting a large budget surplus develop and "choke off" the recovery.
16. Real GDP is likely to be lower than expected. The greater consumer spending that results from lower tax payments may keep the decline in real GDP from being as large as it would otherwise have been.
18. There may be some truth in the columnist's argument, but borrowing to pay the bills is a bad policy for a household, business, or government when the bills are for current expenses, but not a bad policy if the bills are for long-lived capital goods. The alternative is for the government to pay for long-lived capital goods out of the tax revenues received in the year the goods were purchased. But that means that the taxpayers in that year have to bear the whole burden of paying for the projects even though taxpayers for many years in the future will be enjoying the benefits.
20. Two arguments in favor of a flat tax would be the reduction in the paperwork and compliance cost of the income tax system and the potential increases in labor supply, savings, and investment that would result from a lower marginal tax rate. Two arguments against the flat tax would be that the complexities in the current tax code exist because the government pursues some other policy goals and the income distribution would become more unequal by reducing the marginal tax rate on high-income taxpayers.
Chapter 28
Money, Banks, and the Federal Reserve System to 235
Answers End-of-Chapter Problems and Applications
2.
a. Point B on the Phillips curve graph represents the same economic situation as point A on the
aggregate demand and aggregate supply graph. b. Point B on the Phillips curve graph represents the same economic situation as point B on the aggregate demand and aggregate supply graph. c. Point A on the Phillips curve graph represents the same economic situation as point C on the aggregate demand and aggregate supply graph.
4.
In the 1960s the Phillips curve was widely viewed as a stable relationship representing a policy menu
of choices between low inflation and high unemployment, and high inflation and low unemployment. Today, the Phillips curve is not viewed as a policy menu and in the long run there is no tradeoff between inflation and unemployment.
6.
8. The Fed does not want a higher rate of inflation to persist, because if it does, the Phillips curve may shift up, which will make the short-run tradeoff between unemployment and inflation worse.
236 Chapter 13
10. As discussed in Making the Connection 16-1, there is some evidence that the general public does not think that nominal wages keep up with inflation, which means real wages fall.
12. Disinflation is a decline in the inflation rate. When the inflation rate declines, so do nominal interest rates.
14. Agree. A structural relationship depends on the basic behavior of consumers and firms and remains unchanged over long periods.
16.
The supply shock will shift the short-run Phillips curve up to show that the inflation rate and unemployment rate both increased. If the Fed keeps monetary policy unchanged, a recession will result. This will result in workers and firms lowering their expectations of future inflation, and the short-run Phillips curve will shift back down to its previous position. Eventually the unemployment rate will return to the natural rate of 5 percent.
Money, Banks, and the Federal Reserve System 237
18. The Federal Reserve is likely to have kept interest rates higher and allowed the money supply to increase more slowly.
20.
A rules strategy would have been more important to the Federal Reserve of the 1970s, because it had
lost its credibility. Today the Federal Reserve has earned a much higher level of credibility.
238 Chapter 13
Chapter 29
Answers to End-of-Chapter Problems and Applications
2. The best way to answer this question is by placing the values given into a table like Table 17-1: Current Account Exports of Goods Imports of Goods Balance of Trade Exports of Services Imports of Services Balance of Services Income Received on Investments Income Payments on Investments Net Income on Investments Net Transfers Balance on Current Account Financial Account Increase in foreign holdings of assets in the United States Increase in U.S. holdings of assets in foreign countries Net Capital Flows Statistical Discrepancy Balance of Payments
$856 $1,108 $252 $325 $256 $69 $392 $315 $77 $60 $166
$1,181 $1,040 $141 $25 0
4. Yes. Because a country can run a trade deficit and have a current account surplus, it can simultaneously run a trade deficit and a financial account deficit.
6. The U.S. financial account must have been in deficit if the current account was in surplus.
8. Because the United States usually runs a surplus on the balance of services.
Money, Banks, and the Federal Reserve System 239
10.
An increase in interest rates in Europe would increase the desire to invest in financial assets in Europe
relative to the United States. The demand for dollars would fall, causing the exchange rate for the dollar to fall. In the graph the exchange rate falls from 1 to 2.
240 Chapter 13
12. a. The dollar appreciated against the yen. It takes 130 yen to purchase a dollar instead of 120 yen.
b. ii. or iii. could have caused the shift in demand shown.
14. A currency appreciation is good news for the country's consumers, because imports will cost less. It is bad news for the country's businesses that export their products, because the exports will cost more. If a business does not export products, but imports parts for its products, then the currency appreciation will be good news because the imported parts will cost less.
16. Following the same procedure as in Solved Problem 17-3: 1. SPrivate = Y+ TR C T 2. SPublic = T (G + TR) 3. Y = C + I + G + NX 4. NX = NFI Equation 1. plus equation 2. is equal to national saving: S = SPrivate + SPublic = (Y + TR C T) + (T (G + TR)) = Y C G Transfer payments do not appear in the simplified expression for national saving, so the remaining steps are the same as in Solved Problem 17-3: S = (C + I + G + NX ) C G and simplifying: S = I + NX Finally, substituting net foreign investment for net exports: S = I + NFI
18. The U.S. is relying on a financial account surplus to offset a current account deficit.
20. a. Japanese towel producers would benefit from the reduction in competition. b. Chinese towel producers would be hurt by the loss of the Japanese market.
Money, Banks, and the Federal Reserve System 241
c. Japanese consumers would be hurt by higher towel prices and, possibly, a reduction in the variety of towels available on the Japanese market. d. e. Japanese net exports would increase (at least in the short term). Japanese net foreign investment would increase (at least in the short term).
22. A reduction in capital inflows into the United States results in an increase in net foreign investment. As foreign investors decrease their demand for investments in the United States, they are also decreasing their demand for dollars, which causes the exchange value of the dollar to decline.
24. As the U.S. economy has become more open, monetary policy has become more effective, and fiscal policy has become less effective.
26. b.
a.
A "strong yen" means a high exchange rate of the yen against other major currencies.
A high exchange rate for the yen makes Japanese exports, like Nintendo products, more expensive and
foreign imports cheaper.
Chapter 30
Answers to End-of-Chapter Problems and Applications
2. "Soft currency" is a term from journalism, rather than from economics. In this context it means a foreign currency that is losing value in exchange for U.S. dollars. This would hurt DuPont's sales by raising the foreign currency price of DuPont's products.
4. a. Exchange rate (dollars per yen) = 0.0078 dollars = 1 yen
3.2 billion dollars = 0.0078 dollars. 410 billion yen
b. It would be more favorable from Toyota's point of view if the yen exchanged for fewer dollars. This would reduce the dollar price of Toyota cars in the United States.
6. The value of the Australian dollar should decline relative to the value of the New Zealand dollar. It will take more Australian dollars to buy a New Zealand dollar.
242 Chapter 13
8. To alleviate recession in Germany, interest rates should be lowered. To curb inflation in Ireland, interest rates should be raised. Because they now have the same money, Germany and Ireland cannot have different monetary policies.
10. Before Thailand stopped pegging the value of the baht against the U.S. dollar, an investor could have sold 100 million baht and received $4 million at the par exchange rate of $0.04 = 1 baht. After the peg was abandoned and the exchange rate declined to $0.02 = 1 baht, the investor could have bought 200 million baht with the $4 million received in the earlier exchange. The result would have been a profit of 100 million baht.
12. a. There is a shortage of baht in exchange for U.S. dollars, because at the pegged exchange rate the quantity of baht demanded is greater than the quantity of baht supplied.
b. To maintain the pegged exchange rate, the Thai central bank will have to sell baht in exchange for dollars. The Thai central bank will have to sell 50 million baht per day.
14. Argentina's peg collapsed when it stopped fixing the value of the peso against the U.S. dollar, and the value of the peso declined dramatically. Argentine firms that borrowed dollars had to make interest payments in dollars, but their revenues were in Argentine pesos. After the end of the peg, they needed to spend more pesos in order to buy the dollars the firms needed to make their interest payments.
16. The observations are correct. A weaker dollar means higher inflation because it raises the dollar price of imports. Foreign investors may be less willing to invest in the United States if they believe that the value of the dollar will fall, because it will reduce the return on their investment in terms of the investors' home countries' currencies.
18. The pegged exchange rate of the yuan against the dollar was below the market equilibrium exchange rate the yuan was undervalued. As shown in the graph below, the Chinese central bank would have to supply Y2 Y1 each trading period.
Money, Banks, and the Federal Reserve System 243
20. The Romanian central bank was trying to defend an exchange rate that was above the market equilibrium exchange rate. Traders hoped to profit by first selling leu for dollars and then buying them back after the exchange rate had fallen to the market equilibrium level. The Romanian central bank could only defend the value of the leu by using dollars to buy them. Once it ran out of dollar reserves, it would no longer be able to do this.
22. Molson encountered the problem of having to pay player salaries and other expenses in U.S. dollars, while most of their revenues were in Canadian dollars. The Canadian dollar declined in value relative to the U.S. dollar during the last 10 years Molson owned the Canadiens, which reduced Molson's profits. Gillett will be better able to deal with a decline in the value of the Canadian dollar than did Molson, because he has a larger portion of his revenues in the United States. Gillett will be exposed to the risk
244 Chapter 13
that a fall in the value of the Canadian dollar relative to the U.S. dollar will reduce his profits in the Canadiens, but Gillett has most of his revenues in terms of dollars.