chapter 14
what causes the real world money multiplier to be smaller than the simple deposit multiplier?
1. In calculation of simple deposit multiplier it is assumed that banks do not keep any excess reserve that is entire quantity excess reserves that banks have are loaned out. 2. Second, it has been assumed that person receiving payment through check puts the entire amount in his bank account and does not take out anything as currency which is contrary to the real situation where people do increase the quantum of their currency holding as their holding of checking account increases.
why doe businesses accept paper currency when they know that, unlike a gold coin, the paper currency is printed on is worth very little?
Businesses generally accept paper currency even though they know that paper on which the currency is printed worth very little because they know that paper currency is widely accepted as medium of exchange and if they accept the paper currency in exchange of goods and services then they would also be able to do further transaction with them (like making of factor payments) with ease and also this paper currency will not lose much value over the course of time they will hold it.
what is the difference between commodity money and fiat money?
Commodity money is one that; 1) Is an acceptable means of exchange (money) and 2) Has value as a commodity, which is independent from its value as money. Fiat money is one that; 1) Is decreed by law (Central Bank or other government department) as an acceptable medium of exchange 2) Doesn't have value as a commodity, independent from its value as money.
Suppose you decide to withdraw $100 in cash from your checking account. what is the affect on M1? ignore any actions the bank may take as a result of your having withdrawn the $100.
Currency in circulation as well as checking account deposit is both part of M1. In the given case, $100 is withdrawn from the checking account which means that now they are part of currency in circulation. So, one component (currency in circulation) of M1 is increasing while other component (currency in circulation) is decreasing. This increase in one component and decrease in other component and that also by same amount will keep the overall value of M1 unchanged. So, this transaction will not have any effect on value of M1.
suppose you have $200 in currency in a shoebox in your closet. one day<, you decide to deposit the money in a checking account. briefly explain how this will effect M1 and M2.
Currency in shoe box refers to the currency in circulation and is included in both M1 and M2. Money in checking account or checking account deposits is also included in both M1 and M2. So, this deposit of currency into checking account will increase the one component (checking account deposits) of both M1 and M2 while decrease the other component (currency in circulation) of both M1 and M2 thereby keeping the overall value of both M1 and M2 unchanged. Thus, given transaction will not affect either M1 or M2.
What is hyperinflation? why do governments sometimes allow it to occur?
Hyperinflation - When inflation is extremely rapid, it is called hyperinflation. sometimes governments find it difficult to sell bonds to public as investors are skeptical of their ability to pay back the money and in this case governments force their central banks to purchase the bonds. When central bank buys bonds, the money supply will increase. Rapid increase in money supply led to rapid inflation i.e. hyperinflation.
is the quantity theory of money better able to explain the inflation rate in the long run or the short run? briefly explain
In the long run, the velocity of money can be said to be constant ensuring that the growth of velocity of money is zero. it can be concluded that quantity theory of money is better able to explain the inflation rate in the long run as the difference between the growth in the money supply and growth of real output.
distinguish among money, income, and wealth. which one of the three does the central bank of a country control?
Money - Money is equal to the amount that a person has in hand as currency (paper notes and coins) and that he have in his checking account. Income - Income refers to the total amount that a person earns during a year. Wealth - The difference between the value of total assets of a person and the value of his debt and other financial obligations is called the wealth. Central bank controls the money.
what is the quantity theory of money? what explanation does the quantity theory provide for inflation?
Quantity Theory of Money is a theory about the connection between money and prices that assumes that the velocity of money is constant. As per the equation, M × V = P × Y
give the formula for the simple deposit multiplier. if the required reserve ratio is 20 percent, what is the maximum increase in checking account deposits that will result from an increase in bank reserves of 20,000?
Simple Deposit Multiplier - It is the ratio of the amount of deposits created by banks to the amount of new reserves. =1/RR Increase in bank reserves = $20,000 (Given) Required reserve ratio = 20%, or 0.20 (Given) = 1/0.20 = 5 = $20,000* 5 = $100,000
Suppose you decide to withdraw $100 in cash from your checking account. draw a t account showing the effect of this transaction on your banks balance sheet.
Suppose before the withdrawal of $100, total deposits with the bank is $1000. assets: reserves 1000 liabilities: deposits 1000 Now, after the withdrawal of $100, T-account of the bank would be as follows: assets: 900 liabilities: 900
what is the difference between M1 and M2 definitions of the money supply?
The M1 definition of money supply includes; 1) Currency in circulation 2) Checking account deposits 3) Traveler's checks The M2 definition of money supply includes all the components of M1 and also; A. Savings account deposits B. Small denomination time deposits C. Retail money market mutual fund shares
what policy tools does the fed use to control the money supply? which tool is is the most important?
The actions of Fed are successful in managing the money supply and interest rates to achieve macroeconomic policy objectives. Fed mainly uses three policy tools to control the money supply. They include: • Open market operations • Discount policy • Reserve requirement The most important tool the Fed uses to control the money supply among the above three is open market because of the following three reasons: • By open market operations, it completely controls the volume. • Can make both large and small open market operations. • Quick implementation with no administrative delays. Therefore, open market operations act as the most important tool used by Fed.
what does it mean to say that banks "create money"?
The banks 'create money' implies that banks engineers an increase in money supply by bringing an increase in quantum of checking account deposits (a component of money supply).
what are the four functions of money? can something be considered money if it does not fulfill all four functions?
The four functions of money are; 1) Medium of exchange Money serves as a medium of exchange. It is used in exchange for goods and services. 2) Unit of account Money is used to express the value of all goods and services. 3) Store of value Money serves as a store of value or purchasing power. Money possesses stable purchasing power for its holder 4) Standard of deferred payment Credit transactions often involve a promise to pay money at a certain time in future as payment for the goods / services received.
what are the largest asset and liability of a typical bank?
a typical bank's largest asset is Loans. Largest liability of a typical bank is its deposits.
list the federal reserves tools of monetary policy
discount policy reserve requirements open market operations
"inflation is always and everywhere a monetary phenomenon" Milton Freidman explain with reference to quantity theory of money as appropriate
implies that a massive increase in central bank money can bring about inflation or turn deflation into inflation. according to the quantity theory of money MV=PY % change in M+ % change V= % change in P+ % change in Y Assume that velocity is constant and also using a bit of algebra % change M= % change in P+ % change Y % change in M- % change in Y=% change in P
thinking about the attributes of something we use as money, briefly evaluate ice as a currency
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why does an open market purchase of treasury securities by the federal reserve increase bank reserves? why does an open market sale of treasury securities by the federal reserve decrease bank reserves?
open market purchase of Treasury Securities by Federal Reserve brings an increase in bank reserves. open-market sale of Treasury securities by Federal Reserve brings a decrease in bank reserves.
A baseball fan with a Mike Trout baseball card wants to trade it for a Miguel Cabrera baseball card, but everyone the fan knows who has a Cabrera card doesn't want a Trout card.what do economist call the problem this fan is having?
such kind of problem is said to be the problem of "Double coincidence of wants" In this kind of problem, one who is willing to trade one's own things A with thing B does not find a party with thing B who at the same time is willing to trade it with thing A
suppose i desire to put more cash in my emergency bag, so i go and withdraw $500 from my checking account at bank of America. by how much does this withdraw ultimately change deposits throughout the entire financial system, assuming the required reserve ratio of 10 percent and complete lending of excess reserves? how much does it change the money supply?
total deposits would fall by $500 required reserves would fall by $50 (0.1*500) excess reserves would fall by $450 (500-50)