e330ps5a_f06 - Economics 330 Fall 2006 University of...

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1 Economics 330 Menzie D. Chinn Fall 2006 Social Sciences 7418 University of Wisconsin-Madison Problem Set 5 Answers Due in lecture on Wednesday, December 13 th . No late submissions will be accepted. Make sure your name is on your problem set, as well as the name of your ( official ) TA. 1. “In a world with currency holdings and where banks hold excess reserves, if reserve requirements on checkable deposits were set at zero, the amount of multiple deposit expansion would go on indefinitely.” Is this statement true, false, or uncertain? Explain. False. There would still be leakage into currency and excess reserves that would limit the increase in deposit expansion. We can also see this in Equation (4) because the denominator will not equal zero if r = 0; therefore, the money multiplier will not be infinite. 2. Why might the procyclical behavior of interest rates (rising during business cycle expansions and falling during recessions) lead to procyclical movements in the money supply? The rise in interest rates in a boom increases the cost of holding excess reserves and the incentives to borrow from the Fed. Therefore, e falls, which increases the amount of reserves available to support checkable deposits, which raises the monetary base. The result is a higher money supply during a boom. Similarly, when interest rates fall during a recession, the money supply also has a tendency to fall because e rises. 3. “The only way that the Fed can affect the level of borrowed reserves is by adjusting the discount rate.” Is this statement true, false, or uncertain? Explain your answer, using graphs if helpful. False. The Fed also can affect the level of borrowed reserves by directly limiting the amount of discount loans an individual bank can have. (Although the text mentions that for the overall economy, it will be hard to control borrowed reserves w/o resort to changing the discount rate.) 4. If the Fed has an interest-rate target, why will an increase in the demand for reserves lead to a
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This note was uploaded on 02/13/2012 for the course ECON 101 taught by Professor Teerana during the Spring '11 term at Thammasat University.

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e330ps5a_f06 - Economics 330 Fall 2006 University of...

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