Sean Faria

(sean.faria001)

ECO 2013

Assignment 13 (13+14)

1.

a. Reserves provide the Fed a means of controlling the money supply. It is through

increasing and decreasing excess reserves that the Fed is able to achieve a money

supply of the size it thinks best for the economy.

b. Reserves are assets of commercial banks because these funds are cash belonging to

them; they are a claim the commercial banks have against the Federal Reserve Bank.

c. Reserves deposited at the Fed are a liability to the Fed because they are funds it owes;

they are claims that commercial Banks have against it.

d. Excess reserves are the amount by which actual reserves exceed required reserves.

e. Excess reserves equal the actual reserves minus the required reserves. Commercial

banks can safely lend excess reserves, thereby increasing the money supply.

2.

The most common mechanism used to measure this increase in the money supply is

typically called the money multiplier. It calculates the maximum amount of money that

an initial deposit can be expanded to with a given reserve ratio. The money multiplier,

m, is the inverse of the reserve requirement, R (the reserve ratio).

3.

a.

i. The basic determinant of the Transactions Demand for Money is Nominal GDP.

The level of nominal GDP: The higher this level, the greater the amount of

money demanded for transactions.

ii. The basic determinant of the Asset Demand for Money is the interest rate: The

higher the interest rate, the smaller the amount of money demanded as an

asset.

b. The equilibrium interest rate is determined at the intersection of the total demand for

money curve and the supply of money curve.

c. As interest rate decreases the demand for money increases the true is the same for vice

versa.

4.

The Discount Rate is the interest rate the Fed offers to member banks and thrifts who

need to borrow money to avoid having their reserves dip below the required minimum.

The higher the discount rate, the higher mortgage interest rates will be. When the

discount rate goes up, the prime rate goes up as well, which slows the demand for new

loans, and cools the housing market. The opposite is also true. If the fed lowers the

discount rate, the prime rate will come down, and mortgage interest rates will dip to

more favorable levels. Prime Rate is the interest rate offered by commercial banks to its

most valued corporate customers.

5.
a. Cyclical asymmetry refers to the condition where a tight monetary policy is relatively

potent at contracting economic activity, while an easy money policy is relatively weak at

stimulating an economy. The weakness in easy money policy results when, even though

the Fed increases liquidity (reserves) in the system, potential borrowers are unwilling to

spend (often because of uncertainty over general weakness in the economy).

b. If pursued vigorously, a tight money policy could deplete commercial banking reserves

to the point where banks were forced to reduce the volume of loans. The Fed can turn

down the monetary spigot and eventually achieve its goal. The Fed can create excess

reserves, but it cannot guarantee that the banks will actually make the loans and thus

increase the supply of money. If commercial banks, seeking liquidity, are unwilling to

lend, the efforts of the Fed will be of little avail. Furthermore, a severe recession may so

undermine business confidence that the investment demand curve shifts to the left and

frustrates an easy money policy.

c. Yes the Federal Reserve Lowers Interest Rates again and the current mortgage interest

rates have risen.