ps8ans-1 - ECON 205: PRINCIPLES OF MACROECONOMICS FALL 2008...

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ECON 205: PRINCIPLES OF MACROECONOMICS FALL 2008 MARK MOORE PROBLEM SET 8: SOLUTIONS 1. Assume that the buried treasure is cash. The assumptions stated in the problem assume that the treasure is deposited in a bank. As a result, the money supply increases by $120 million - $12 million = $108 million. We have to subtract the initial $12 million because the value of the treasure does not constitute an addition to the money supply. Note that the $120 million (=$12 million/0.1) is the total increase in deposits. 2. If the reserve ratio were 25%, the total change in deposits would be $12 million/0.25=$48 million, so the total change in the money supply would be $48 million -$12 million = $36 million. If the reserve ratio were 100%, the total change in deposits would be $12 million, and the total change in the money supply would be zero. 3. a and c. These transactions have no effect on the overall money supply. To make this clear, suppose you withdraw $100 from Bank A , and the concert promoter deposits your $100 in its account at Bank A. In this case, Bank A has no change in its deposits, so nothing changes. If the concert promoter deposits the $100 in a different bank, say Bank B, then Bank A and Bank B will have offsetting transactions. b. Sam deposits $100 in Bank A, and the required reserve ratio is 12.5%. Initially, Bank A’s balance sheet changes as follows: Change in Assets Change in Liabilities +$100 Reserves +$100 Checking Deposits Change in Reserves Actual Reserves +$100 Required Reserves +$12.50 Excess Reserves +$87.50 After Bank A lends out its additional excess reserves, the change in Bank A’s balance sheet looks like the following: Change in Assets Change in Liabilities +$12.50 Reserves +$100 Checking Deposits +$87.50 Loans
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Change in Reserves Actual Reserves +$12.50 Required Reserves +$12.50 Excess Reserves +$0 These loans are then deposited elsewhere and the money creation process continues. The total change in deposits is $100/0.125 = $800. The total change in the money supply is $800 - $100 = $700. Remember, the initial $100 was in cash, which is part of the money supply. 4. When funds are deposited in a bank, the bank holds only a fraction of the value of deposits in reserves. The remaining funds are used to make loans, which pay a return. (Banks also use funds that are deposited to purchase government bonds, but this practice
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This note was uploaded on 06/17/2009 for the course ECON 20091_ECO taught by Professor Mohammadsafarzadeh during the Fall '09 term at USC.

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ps8ans-1 - ECON 205: PRINCIPLES OF MACROECONOMICS FALL 2008...

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