Help Out A Fellow Classmate - Topic C Posted Wednesday

Topic C Posted Wednesday Help Out A Fellow Classmate1 Assuming T

Assuming these numbers from the Federal Reserve Bank, now assume that the public deposited another $15 billion in cash in transactions accounts. Total reserves: $35 billion, transactions deposits: $650 billion, cash held by the public: $250 billion, required reserve ratio: 0.05.

a. How large would the money supply be if the banks fully utilized their lending capacity?

b. How much would the total lending capacity of the banking system be after this portfolio switch?

Suppose the Federal Reserve decided to sell $20 billion worth of government securities in the open market. How will the lending capacity of the banking system be affected if the reserve requirement is 5 percent?

From the end of 2006 to the end of 2007, M1 increased from $1,373 billion to $1,434 billion.

a. By what percentage did M1 increase?

b. If the Fed had used a fixed rule of 3 percent growth of the money supply, how large would M1 have been in 2007?

Washington, D.C.—The U.S. Congress gave final approval to President Obama’s $787 billion stimulus package yesterday. The $787 billion package is intended to give a boost to the economy, lifting it out of the current recession. If consumers had an MPC of 0.90, by how much would aggregate demand have eventually increased with Obama’s spending stimulus, assuming the stimulus was entirely government spending?

Paper For Above instruction

The interplay of monetary policy, fiscal measures, and consumer behavior profoundly influences the U.S. economy’s trajectory. This paper analyzes several facets of these mechanisms, focusing on the impact of banking reserve management, fiscal stimulus, and the growth of the money supply between 2006 and 2007. By exploring these elements, we gain a comprehensive understanding of how policy decisions and economic variables shape macroeconomic stability and growth.

Impact of Increased Deposits on Money Supply

The given scenario states that an additional $15 billion of cash is deposited into transaction accounts, with total reserves now at $35 billion, and transactions deposits at $650 billion. The reserve requirement ratio is 5% (0.05). To determine the potential maximum size of the money supply if banks fully utilize their lending capacity, we first calculate the excess reserves and the reserve requirement.

Reserve requirement: 5% of $650 billion transactions deposits equals $32.5 billion. Currently, reserves stand at $35 billion. With an additional deposit of $15 billion, reserves increase to $50 billion. However, since total reserves now surpass the reserve requirement, banks can lend out the excess reserves.

Excess reserves = Total reserves - Required reserves = $50 billion - (0.05 × $665 billion) = $50 billion - $33.25 billion = $16.75 billion.

Applying the money multiplier, calculated as 1 divided by the reserve ratio (1 / 0.05 = 20), the maximum potential increase in the money supply from these excess reserves is:

Money supply increase = Excess reserves × Multiplier = $16.75 billion × 20 = $335 billion.

Adding this to the existing scope of the money supply (transactions deposits), the total approximated money supply would be the original deposits plus the new potential lending, i.e., $665 billion (original deposits plus the new deposit) + $335 billion, resulting in a total of approximately $1,000 billion or $1 trillion.

Effect of Portfolio Switch on Lending Capacity

If the banking system switches from holding more cash and reserves to increasing lending, their total lending capacity depends on reserves and the reserve ratio. After shifting cash holdings into reserves or lending, the maximum lending capacity remains a function of excess reserves.

Given the initial parameters, the total lending capacity after reallocating assets or securities is similar to the previously calculated excess reserves' effect. Assuming the $15 billion shifted into reserves enhances the system’s capacity, the overall potential lending becomes: $16.75 billion (from above). Multiplying by the money multiplier (20), the new lending capacity can be estimated as $335 billion.

Effect of Federal Reserve's Open Market Operations

When the Fed sells $20 billion worth of government securities, it withdraws liquidity from the banking system, reducing reserves. At a reserve requirement of 5%, the reduction in reserves impacts the banks’ lending capacity.

Reserves reduction: $20 billion. The decrease in excess reserves, and therefore in lending capacity, is computed as:

Decreased excess reserves = $20 billion, which, when multiplied by the money multiplier (20), indicates a maximum potential contraction in the money supply of:

$20 billion × 20 = $400 billion.

This demonstrates that open market sales tighten liquidity, diminishing the possible volume of bank loans and, consequently, shrinking the overall money supply.

Growth of M1 from 2006 to 2007

In 2006, M1 was $1,373 billion; in 2007, it grew to $1,434 billion. The percentage increase is calculated through:

Percentage increase = [(1,434 - 1,373) / 1,373] × 100 ≈ (61 / 1,373) × 100 ≈ 4.44%.

Thus, M1 increased by approximately 4.44% over that period.

If the Federal Reserve adhered to a fixed growth rule of 3% annually, the projected M1 for 2007 would be:

Projected M1 = 2006 M1 × (1 + growth rate) = $1,373 billion × 1.03 ≈ $1,414 billion.

In real terms, this indicates that the actual growth exceeded the fixed 3% rule, reflecting expansionary monetary policy during that interval.

Impact of Fiscal Stimulus on Aggregate Demand

President Obama’s $787 billion stimulus package aimed to counteract recessionary pressures. With an MPC of 0.90, the fiscal multiplier effect magnifies initial government spending through increased consumption.

The multiplier (k) is given by:

k = 1 / (1 - MPC) = 1 / (1 - 0.90) = 10.

Thus, the total increase in aggregate demand can be approximated by:

Increase in AD = Multiplier × initial government spending = 10 × $787 billion = $7,870 billion.

This indicates a substantial potential boost to economic activity, assuming full multiplier effect and no leakages.

Despite these optimistic calculations, real-world factors like gradual implementation and external shocks may influence actual outcomes. Nonetheless, this example highlights the profound impact fiscal policy can have when consumer spending behaviors align with policy intent.

Conclusion

The analysis of banking reserve management, open market operations, money supply growth, and fiscal policy underscores the complexity and interconnectedness of macroeconomic mechanisms. Effective policy implementation requires a nuanced understanding of these relationships to foster economic stability, growth, and resilience against shocks. Future policies must balance liquidity management, fiscal spending, and monetary targets to optimize macroeconomic outcomes.

References

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• Mankiw, N. G. (2021). Principles of Economics (9th ed.). Cengage Learning.
• Federal Reserve Bank of St. Louis. (2023). Money Supply Data. Retrieved from https://fred.stlouisfed.org/
• Cecchetti, S. G., & Schoenholtz, K. L. (2020). Money, Banking, and Financial Markets (5th ed.). McGraw-Hill Education.
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• Congressional Budget Office. (2020). The Impact of Fiscal Policy. CBO Reports.
• Bernanke, B. S. (2012). The Federal Reserve and the Financial Crisis. Princeton University Press.
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