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HW_1_Solutions_Fractional_Reserve[1]

HW_1_Solutions_Fractional_Reserve[1] - HW 1 Solutions 1...

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HW 1 Solutions 1. Assume Bank A receives $100 in deposits from the Fed and reserve requirement is 40%. In the following table write out the money multiplication process. Only write out the money multiplication process until Bank E but calculate the Total as if you continued the multiplication process until reserves hit zero and there is nothing left to lend. Bank Deposits Loans Reserves A 0 100 0 B 100 60 40 C 60 36 24 D 36 21.6 14.4 E 21.6 12.96 8.64 Total 250 250 100 2. How much actual money is there in the banking system, M0, and how much demand deposits are there in the banking system, M1? How much money was created through lending? Only $100 is actual money, M0, and there are now $150 additional created dollars though bank loans that increase M1 to $250. 3. What are the pros and cons of fractional reserve banking and the gold standard Gold is not flexible, scarce. However, it cannot be manipulated. Paper Money is more flexible. Not scarce. However, it can be manipulated. Will gold lose its value? If there is hyperinflation I will buy gold. In 1980 gold in today's dollars was 2,400. Today, gold is 1,700. Back in 1980 we had oil shocks, hyperinflation. The dollar is going to be worthless. I will buy gold. By late 1990s gold was in the 200 range in today's dollars. 4. Should banks be required to hold more or less reserves? This matter of debate and there is not right or wrong answer. Famous economists have called for 100% reserve requirement. This means whatever money you give to the bank they will hold all your money in the bank safely at all times. No threat of bank panics or banks making risky loans with your money. However, you will have to pay a larger fee for this safeguarding your money. Also, they could not lend. Therefore, lending would be done by other institutions and be perhaps more unregulated.
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