Unemployment rate: > 8.5% Velocity of money = 6 Price Level = 1.5 RealGDP = $3,2
ID: 1117193 • Letter: U
Question
Unemployment rate: > 8.5%
Velocity of money = 6
Price Level = 1.5
RealGDP = $3,200
Total Bank Reserves in banking system: $ 80
Amount of Total Bank Reserves that are “excess reserves”: $ 0
Total checkable deposits in banking system: $ 400
Estimate of RealGDP if full employment existed: $3,500
QUESTIONS:
1) In nominal terms, how big is the GDP gap (using this price level)?
2) How much additional M1 is needed to close the GDP gap (assume no inflation and constant velocity)?
3) Given the additional M1 needed (previous question), if the central bank assumes the maximum money multiplier, how large of an initial change in bank reserves must the central bank trigger?
4) To achieve the initial change in bank reserves you calculated in the previous question, which action/announcements should the central bank make (multiple choice)?
Explanation / Answer
Unemployment rate: > 8.5%
Velocity of money = 6
Price Level = 1.5
RealGDP = $3,200
Total Bank Reserves in banking system: $ 80
Amount of Total Bank Reserves that are “excess reserves”: $ 0
Total checkable deposits in banking system: $ 400
Estimate of RealGDP if full employment existed: $3,500
QUESTIONS:
1) In nominal terms, how big is the GDP gap (using this price level)?
Nominal GDP = 3200*1.5 = 4800. Full employment GDP = 3500*1.5 = 5250. Recessionary gap = $450
2) How much additional M1 is needed to close the GDP gap (assume no inflation and constant velocity)?
GDP gap is 450. Money supply = Nominal GDP/ velocity = 3200 x 1.5/6 = 800.
For GDP to be 3500 x 1.5, money supply should be = 3500 x 1.5/6 = 875
Required increase in M1 = $75
3) Given the additional M1 needed (previous question), if the central bank assumes the maximum money multiplier, how large of an initial change in bank reserves must the central bank trigger?
Money multiplier = 1 + C-D/ C-D + RR-D + ER-D. Here C-D is zero, RR-D = 80/400 = 20% and ER-D = 0%. Hence money multiplier mm = 1/20% = 5
To increase the money supply by 75, reserves should be increased by 75/5 = $15
4) To achieve the initial change in bank reserves you calculated in the previous question, which action/announcements should the central bank make (multiple choice)?
It can reduce discount rate, reserve requirement or it can conduct open market operations of buying government securities
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