1. Consider a particular bank’s policy is to maintain 12% of deposits as reserves. The bank currently has $10 million in deposits and holds $400,000 excess reserves. What is the required reserve on a new deposit of $50,000?
2. The short-term nominal interest rate is 5% with an expected inflation of 2%. Economists forecast that next year’s nominal rate will increase by 100 basis points, but inflation will fall to 1.5%. What is the expected change in real interest rates?
3. If the required reserve ratio is 20%
a) How much of a new $10,000 deposit can a bank lend?
b) What is the potential impact on the money supply?
c) Now suppose that banks actually hold 25% in reserves and individuals hold 15% of deposits in cash. What is the actual impact on money supply?
4. A bank currently holds $150,000 in excess reserves. If the current reserve requirement is 12.5%, how much could the money supply change?
5. The trading desk at the Federal Reserve sold $100,000,000 in T-bills to the public.
a) If the current reserve requirement is 8.0%, how much could the money supply change?
b) If banks actually hold 10% in reserves and individuals hold 10% of deposits in cash. What is the actual impact on money supply?
6. Suppose that the new Chairman of the Federal Reserve cares about the level of output Y and the inflation rate i in a way that can be expressed by the following utility function:
U(i, Y) = -0.5(i – i*)2 - 0.1(Y – Y*)2
where i* is the target inflation rate for bank, and Y* is the target level of aggregate output. Now suppose the Phillips Curve can be expressed as: i – ie = 0.05(Y – YT)
where ie is the private sector’s anticipated inflation rate and YT is trend output. Suppose Y* = YT = 100, i* = 0.02, and ie = 0.03.
a) What inflation rate will the Chairman prefer in this situation?
b) Now suppose the expected inflation rate ie = 0.015. What inflation rate would the Chairman prefer in this situation?
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