ECON 2200 ASSIGNMENT

Subject: Economics    / Accounting

Questions:

Question
10. Now suppose the interest rate is currently 9%, the reserve ratio is 25%,and the Fed would like to adjust
interest rates enough to increase Investment spending (I) by $40. The Fed would need to (buy, sell) sell
T
bills in the amount of $ __10______which would increase the money supply by $3 and decrease interest
rates by___4_____%.
11. The equilibrium interest rate is currently 6%, while the reserve ratio is 10%. The banking system currently
has required reserves of $20 and zero excess reserves. The Fed decides to increase the reserve ratio to 20%.
The money supply will (increase, decrease) __decrease______ by $ _10_______ as a result of this change,
causing the interest rate to increase to ___5_____% and investment spending to (increase, decrease)
___decrease_____ to $ __6______. 10. Now suppose the interest rate is currently 9%, the reserve ratio is 25%, and the Fed would like to adjust
interest rates enough to increase Investment spending (I) by $40. The Fed would need to (buy, sell) ________
T bills in the amount of $ ________ which would (increase, decrease) _______the money supply by ________
which would (increase, decrease) __________ interest rates by ________%.
This one is a bit different though you start the same by determining what the equilibrium MS is when
the interest rate is 9% (graph 1). You also need to determine the multiplier (1/rr).
Next you need to look at the second graph and see what Investment Spending is at 9% and then
determine what the interest rate would have to be to increase Investment Spending by $40 from the
amount at 9%. Would the interest rate need to increase or decrease? By how much? (answers to the
last two blanks).
Then you need to look at the first graph again and determine how much the MS would have to change
to bring about the desired change in the interest rate. (Middle two blanks)
Finally, using the multiplier you must determine how many dollars worth of T-bills the Fed would have
to buy or sell. To do that divide the amount the money supply must change by the multiplier (?excess
reserves = ?MS / the multiplier). (First two blanks)
11. The equilibrium interest rate is currently 6% while the reserve ratio is 10%. The banking system currently
has required reserves of $20 and zero excess reserves. The Fed decides to increase the reserve ratio to 20%.
The money supply will (increase, decrease) ________ by $ ________ as a result of this change causing the
interest rate to (increase, decrease) to ________% and investment spending to (increase, decrease)
________ to $ ________. On this one you must first determine how much checkable deposits the banking system currently has.
To do so you will use the rr = 0.10 and the fact that excess reserves (ER) equal 0 and required reserves
(RR) equal $20. You know that RR = rr x checkable deposit or $20 = 0.10 x checkable deposits. This
could be rewritten as checkable deposits = $20 / 0.10.
Now that you have decided how much checkable deposits the banking system has you can determine
what happens if the Fed then raises the reserve requirement to rr = 0.20. The banks will now need to
hold 20% of checkable deposits as required reserves (RR = rr x checkable deposits).
What happens to excess reserves (ER)? Will they increase or decrease? Will that cause the money
supply to increase or decrease? Remember ER = TR – RR. You started with ER = 0. If the change in
the reserve requirement increased RR while TR remained constant, then ER must decrease. How
much was the change in ER? How does a decrease in ER affect the money supply?
To determine how much the money supply changes, you must determine the new multiplier using the
new rr (0.20). The multiplier times the change in ER gives you the change in MS. ?MS = ?ER x 1/rr.
Finally, you must determine the original MS (at 6% on the 1st graph) and add/subtract the change in MS
to determine the new equilibrium MS. Once you have that just find the new interest rate on the first
graph and use it to determine the level of Investment Spending on the second graph.