202 Fall 10, PS 3 Discuss

# 202 Fall 10, PS 3 Discuss - ECO 202 Lyons PROBLEM SET III...

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ECO 202, Lyons Fall 2010 PROBLEM SET III DISCUSSION SHEET CHAPTER 9 Problem 6: Assumptions about Gorgonzolan monetary situation: public holds no currency, only bank deposits; banking system’s desired reserve to deposit ratio is 20%. i) The central bank puts 5 million guilders into circulation, which are then deposited in the banking system. The banks’ (consolidated) balance sheet then looks like this: ASSETS LIABILITIES Reserves (currency) 5 million Deposits 5 million ii) If the banks desire a 20% reserve ratio, then their desired reserves are 1 million and they hold excess reserves of 4 million. They therefore issue loans of 4 million (in currency), and their balance sheet looks like this: ASSETS LIABILITIES Reserves (currency) 1 million Deposits 5 million Loans 4 million iii) The proceeds of the loans are then re-deposited in the banks, adding to the banks’ deposit liabilities and to their assets, and their balance sheet now looks like this: ASSETS LIABILITIES Reserves (currency) 5 million Deposits 9 million Loans 4 million iv) Again, the banks calculate their desired reserves (20% of deposits), finding 1.8 million is needed, with excess reserves of (5 - 1.8) = 3.2 million. They make loans in this round of 3.2 million, which are then re-deposited, and the balance sheet looks like this: ASSETS LIABILITIES Reserves (currency) 5 million Deposits 12.2 million Loans 7.2 million v) This process of calculating excess reserves, making loans, and receiving new deposits can continue until the banks collectively hold reserves equal to 20% of their deposits. The final balance sheet in this process looks like this: ASSETS LIABILITIES Reserves (currency) 5 million Deposits 25 million (also = “money supply”) Loans 20 million

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ECO 202, Lyons Problem Set 3 Discussion, page 2 9th November 2010 CHAPTER 10 Problem 3: Year Real GDP(Y) Y growth Potential GDP (Y*) (Y-Y*)/Y* Gap Type \$ bill. % per year \$ bill. in % 1999 9470 9248 2.4 expansionary 2000 9817 3.6 9590 2.4 expansionary 2001 9891 0.8 9927 - 0.4 recessionary 2002 10049 1.6 10227 - 1.7 recessionary 2003 10301 2.5 10501 - 1.9 recessionary 2004 10676 3.6 10777 - 0.9 recessionary 2005 11003 3.1 11068 - 0.6 recessionary 2006 11319 2.9 11372 - 0.5 recessionary 2007 11567 2.2 11687 - 1.0 recessionary The recession occurred in 2001, but did not last a full year; real growth was positive but very slow, and was linked to a shift of the actual size of the economy from above to below potential, where it has remained (including 2008 & 2009, 2010 and probably 2011). That is, the positive
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202 Fall 10, PS 3 Discuss - ECO 202 Lyons PROBLEM SET III...

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