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Problem Set #4

You need to show your calculations to get full credit.

1. Suppose a student writes a check in the amount of $300 to the college bookstore for textbooks. Discuss briefly the impact on the student's balance sheet, his/her bank's balance sheet, the bookstore’s bank’s balance sheet and the balance sheet of the Fed. (5 Points)

2. You are given the following information: Reserves in the banking system amount to $48 billion, of which $45.8 billion are required. Currency in the hands of the public amounts to $692.5 billion while checkable deposits amount to $650 billion. Calculate the money multiplier. (5 Points)

3. Consider an open market purchase by the Fed of $3 billion of Treasury bonds.  Using T-accounts, show the impact of the purchase on the bank from which the Fed bought the securities. Then, assuming the required reserve ratio is 10 percent, the bank does not want to hold extra reserves, and the public does not want to hold currency, compute the impact on M1. (5 Points)

4. Using T-accounts, explain what happens to the balance sheets of the relevant entities in each of the following cases. How does the monetary base change in each case? (10 Points)

a. The Fed buys a $1,000 Mortgage Backed Security from a mutual fund (assume the transaction goes through a commercial bank).

b. Bank of America pays back a $10,000 discount loan.

c. The Treasury transfers $3mln from its account at Bank of America to its account at the Fed.

5. Suppose you examine the central bank’s balance sheet and observe that since the previous day, reserves have fallen by $100 million. In addition, on the asset side of the central bank’s balance sheet, securities have fallen by $100 million. (10 Points)

a) What activity might the central bank have carried out earlier in the day to lead to these changes in the balance sheet?

b) Do you think the central bank was aiming to increase, decrease or maintain the size of the money supply by carrying out this activity?

c) Was the size of the banking system’s balance sheet affected by these changes to the central bank’s balance sheet?