Solution to Problem Set 15-16 (ECO100)

Solution to Problem - Prof Gustavo Indart Department of Economics University of Toronto ECO100Y INTRODUCTION TO ECONOMICS Solution to Problem Set

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Prof. Gustavo Indart Department of Economics University of Toronto ECO100Y INTRODUCTION TO ECONOMICS Solution to Problem Set 15-16 1. (a) CU P = CU – CU B = $30 – $5 = $25 (million) Since CU B = RE – D CB = $15 – $10 = $5 (million) (b) M = CU P + D = $25 + $300 = $325 (million) (c) In the absence of any cash drain from the banking system, mm = 1/v and v = RE/D = 15/300 = 0.05, and then mm = 1/0.05 = 20. (d) Assets: D CB = $10 Liabilities: D = $300 Loans = $285 CU B = $5 2. If the Central Bank buys $1 million in Government Bonds from the public, the stock of high-powered money (or monetary base) increases by this amount. Therefore, since mm = 20, deposits will increase by $20 million once all excess reserves are eliminated. Assuming no cash drain from the banking system, the money supply will increase by this amount. The money supply increases by more than the value of the purchase of government bonds from the public because the chartered banks will try to eliminate any excess reserves, thus creating new money in the process. The changes in the balance sheets of the public, the chartered banks, and the Bank of Canada are as follows (in thousands): Public Chartered Bank Bank of Canada Assets Liabilities Assets Liabilities Assets Liabilities GB –1000 D +1000 D +19000 L +19000 D BC +1000 L +19000 D +1000 D +19000 GB +1000 D BC +1000
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2 3. (a) mm = 1/v and v = 0.1. Therefore, mm = 1/0.1 = 10. (b) When the Bank of Canada buys $1billion in Government Bonds from the public, the changes in the balance sheets of the public, the chartered banks, and the Bank of Canada are as follows (in millions): Public Chartered Bank Bank of Canada Assets Liabilities Assets Liabilities Assets Liabilities GB –1000 D +1000 D BC +1000 D +1000 GB +1000 D BC +1000 The public sells an asset in the form of Government Bonds, and the Bank of Canada acquires an asset in the form of Government Bonds. Therefore, the item "Government Bonds" in the assets column decreases by $1000 in the public's balance sheet and increases by the same amount in the Bank of Canada's balance sheet. The Bank of Canada buys these bonds by writing a cheque which the public deposits at the chartered bank. Therefore, the item "deposits" in the assets column of the public increases by $1000. These deposits represent a liability from the point of view of the chartered bank, and thus the liabilities column of the bank increases by $1000. Now the chartered bank has the cheques written by the Bank of Canada and thus holds a claim on the Bank. The chartered bank deposits these cheques at the Bank of Canada, and thus its deposit increases by $1000. After the Bank of Canada's purchase of the bonds, the money supply increased by $1000 (equal to the change in deposits). Also, since the chartered bank’s deposits with the Bank of Canada are part of the chartered bank’s reserves, the reserves increased by $1000. Indeed, since there is no cash drain from the banking system, RE = D CB = $1 billion. Now, through the multiplying mechanism, the money supply will increase by the
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This note was uploaded on 01/16/2011 for the course ECO ECO100 taught by Professor Inheart during the Fall '09 term at University of Toronto- Toronto.

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Solution to Problem - Prof Gustavo Indart Department of Economics University of Toronto ECO100Y INTRODUCTION TO ECONOMICS Solution to Problem Set

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