Which of the Central Bank operations increases the amount of money in circulation?

a) the Central Bank increases the mandatory reserve ratio;

b) the Central Bank transfers government bonds to the population and banks;

c) the Central Bank raises the interest rate at which it lends to banks;

d) the Central Bank buys government bonds on the open market.

 

4. The velocity of money circulation is equal to:

a) the amount of bank loans issued divided by their number of borrowers;

b) price index adjusted for real gross domestic product;

c) the average number of payments in which each monetary unit participates during a year;

d) the average number of transfers of non-cash money per year per commercial bank.

 

Which of the following are money today and which are not? Explain your reasoning in terms of the functions of money.

• Gold

• A Van Gogh’s painting

• A 1-ruble coin

 

Numerical tasks

Write an appropriate equation and use it to compute the answer.

 

1. The nominal GDP is 5,000 money units, one monetary unit makes an average of 2.5 turns per year, and the speculative demand for money is 400 money units. What is the total demand for money?

 

The real volume of production is worth 28 million units, and the rate of circulation of a monetary unit is 7. What will the real money value in the economy?

3. What will be the total increase in the money supply in the country, if the required reserve ratio is 10% and the initial increase in deposits amounted to $ 200 million?

4. Bank deposits increased by 200 million rubles, and the required reserve ratio is 20%. What is the potential increase in money supply?

 

5. The required reserves ratio in the country is 25%. What is the money multiplier?

 

6. Assume that the required reserve ratio is 10 percent, the banks keep no excess reserves, and borrowers deposit all loans made by banks. Suppose you have saved $100 in cash at home and decide to deposit it in your checking account. How much can the money supply increase as a result of your deposit?

 

7. Real GDP last year was $ 300 billion. It increased to 318 billion this year. What will the economic growth rate be? 

 

8. Russia printed additional 500 million rubles. What will an increase in quantity of money supply (money in circulation) be in Russia if the money multiplier is 5?  

 

9. Suppose a bank initially has $10,000 in deposits, reserves of $2,000, and loans of $8,000. 1) At a required reserve ratio of 0.2, is the Bank loaned up? 2) Write the bank’s balance sheet at present. 3) Suppose that the bank customer, planning to take cash on an extended college graduation trip to Germany, withdraws $1,000 from her account. Write the changes to the bank’s balance sheet and its balance sheet after the withdrawal. By how much are its reserves (R) now deficient? The bank would probably replenish its reserves by reducing loans. This action would cause a multiplied contractionof checkable deposits as other banks lose deposits because their customers would be paying off loans to our Bank. 4) How large would the contraction be (-∆D)?

Chapter 5. Financial Markets and the Economy

Unit 5.1 The Bond Market and Macroeconomic Performance

Learning objectives

1. Explain and illustrate how the bond market works and discuss the relationship between the price of a bond and that bond’s interest rate.

2. Explain and illustrate the relationship between a change in demand for or supply of bonds and macroeconomic activity.

3. Explain and illustrate how the foreign exchange market works and how a change in demand for a country’s currency or a change in its supply affects macroeconomic activity.

The connection between the bond market and the economy derives from the way interest rates affect aggregate demand. For example, investment is one component of aggregate demand, and interest rates affect investment. Firms are less likely to acquire new capital (that is, plant and equipment) if interest rates are high; they are more likely to add capital if interest rates are low.

If bond prices fall, interest rates go up. Higher interest rates tend to discourage investment, so aggregate demand will fall. A fall in aggregate demand, other things unchanged, will mean fewer jobs and less total output than would have been the case with lower rates of interest. In contrast, an increase in the price of bonds lowers interest rates and makes investment in new capital more attractive. That change may boost investment and thus boost aggregate demand.

Figure Bond Prices and Macroeconomic Activity

 

Figure Bond Prices and Macroeconomic Activity shows how an event in the bond market can stimulate changes in the economy’s output and price level. In Panel (a), an increase in demand for bonds raises bond prices. Interest rates thus fall. Lower interest rates increase the quantity of investment demanded, shifting the aggregate demand curve to the right, from AD ₁ to AD ₂ in Panel (b). Real GDP rises from Y ₁ to Y ₂; the price level rises from P ₁ to P ₂. In Panel (c), an increase in the supply of bonds pushes bond prices down. Interest rates rise. The quantity of investment is likely to fall, shifting aggregate demand to the left, from AD ₁ to AD ₂ in Panel (d). Output and the price level fall from Y ₁ to Y ₂ and from P ₁ to P ₂, respectively. Assuming other determinants of aggregate demand remain unchanged, higher interest rates will tend to reduce aggregate demand and lower interest rates will tend to increase aggregate demand.