Money Definitions. To answer the following questions, refer to the money definit

Question

Money Definitions. To answer the following questions, refer to the money definitions and relationships

1Total currency = (currency in circulation) + (vault cash)

2Total reserves = (vault cash) + (reserve deposits)

3Monetary Base (MB) = (currency in circulation) + (total reserves)

4M1 = (currency in circulation) + (demand deposits)

5M2 = M1 + (savings deposits) + (small time deposits) + (retail money market accounts)

M2 = M1 + (savings deposits) + (small time deposits) + (retail money market accounts)

For each question, assume that the information given in the previous question still holds.

[2 points] Suppose there is $100 worth of total currency, 10% of which is held in the vaults of banks.How much currency is in circulation?

[2 points] Suppose that banks have a total of $400 worth of reserve deposits at the Fed. What is the value of the monetary base?

[2 points] Suppose the public initially has a total of $100 deposited in checking accounts (demanddeposits). If the public withdraws $10 in cash from their checking accounts, how would the M1 money supply and the monetary base be affected?

Money Creation and Open Market Operations.

[2 points] Briefly explain in words how the “money multiplier” is supposed to work What does Wright say are the limitations of this model of money creation? Also, discuss what options a bank would have if they had a lending opportunity, but didn’t have the reserves available for payment of the loan; what does this mean for the money multiplier story?

the Fed has not used money supply targets as a basis for openmarket operations since the early 1980s. What does the Fed use as a target instead? What actions does the Fed take to achieve this target?

FOMC Monetary Policy Statement On Thursday (Sept. 17th) the Federal Open Market

Committee [FOMC] (a committee within the Fed that is in charge of overseeing open market operations) released their most recent policy statement, which outlines the committee’s stance on monetary policy. Refer to the FOMC’s statement in answering the following questions:

http://www.federalreserve.gov/newsevents/press/monetary/20150917a.htm

[2 points] In the second paragraph of the statement, the FOMC says they expect that “economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate.”

What do they mean by a “dual mandate” (that is, what policy objectives are included in this mandate)?

Does the European Central Bank (ECB) also have a dual mandate? If not, which policyobjective does the ECB focus on?

] In the FOMC’s policy statement, what did the committee announce as its target range forthe federal funds rate (ffr) ? Is this target different from the previous ffr target?

[2 points] If the FOMC decides to raise the ffr target, it would be doing so out of concern for which of its policy objectives? (i.e., which part of the dual mandate would the Fed be focusing on?)

Correspondent Banking and Eurodollar Transactions. Read the following news article, which outlines a recently announced banking relationship that will allow financial transactions to take place between individuals and firms in U.S. and Cuba:

http://www.miamiherald.com/news/business/article28072318.html

[2 points] Using T-accounts (showing changes in assets and liabilities), show the transactions thatwould take place if a U.S. firm (which has an account at Stonegate Bank) pays a Cuban firm (which has an account at Banco Internacional de Comercio); assume the payment is made in U.S. dollars (there should be no foreign currencies involved in any part oy this question.). Hint: you should show the transactions using four T-accounts.

[2 points] Now suppose that the U.S. firm from part (a) doesn’t have an account at Stonegate Bank,but instead has accounts at both Bank of America in New York and Banco Internacional de Comercio in Cuba. Using T-accounts, show the transactions that would take place if the U.S. firm transfers U.S. dollars from their account at Bank of America to their account at Banco Internacional de Comercio. Assume that Bank of America and Stonegate Bank are both parts of the Federal Reserve System. Hint: you should show the transactions using five T-accounts. Also, you may find Stigum ch. 7 to be helpful for this part.

Explain why, during the transaction you described in part (b), dollars never actually left theU.S. banking system.

Explanation / Answer

Suppose there is $100 worth of total currency, 10% of which is held in the vaults of banks. If the banks hold 10% of the currency in their vaults means that they can lend upto $ 90 and this $90 will be in circulation.

Suppose that banks have a total of $400 worth of reserve deposits at the Fed. What is the value of the monetary base. if the Reserve Rate is 10% then the value of monetary base would be $4000.

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