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Assignment: Monetary Policy Problems 1

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Assignment: Monetary Policy Problems 1. If the total required reserves of a commercial banking system is $80 billion and the required reserve ratio on deposits is 10%, What is the maximum level of deposit liabilities they can legally hold? (2) 2. Suppose the central bank of Narnia purchases $10 million of government securities from the Narnian people. Further suppose that the bank pays for these securities by issuing cheques, which the sellers deposit in their chequing accounts in the commercial banking system. a. Use Balance Sheets to show the effects of this transaction. (5) b. In direct consequence of this transaction, "What is the amount and direction of change in Narnia's money supply?" (2) c. If, prior to this transaction, the commercial banks had no excess reserves, and if their required reserve ratio is 10%, determine 1)the amount of excess reserves now and 2) the size of the money multiplier. (5) d. Construct and fill in two Balance Sheets to show the additional changes that would result if the commercial banks decided to loan out all their newly acquired excess reserves. (5) e. What is the direction and magnitude of change in the money supply resulting from the total effect of the Bank of Narnia's open-market purchase of government securities. (2) 3. An Expansionary Monetary Policy (Easy Money) is appropriate during times of recession. It involves the following action-reaction sequence: central bank increases the money supply this leads to lower interest rates → which increase consumer and investment spending → and so Aggregate Demand increases. a. Draw and label two graphs to illustrate this process and its effect on output, employment, income, and price level. (5) b. Do the same thing for the case of a Contractionary Monetary Policy (Tight Money).