Problem Set 5 (Hint: Make Sure You Have Done The Internet)

Problem Set 5 (HINT: Make certain you have done the Internet Activity

Make certain you have completed Internet Activity #5 before attempting this Problem Set. The questions involve calculating monetary aggregates (M1 and M2), understanding the effects of financial transactions on these aggregates, analyzing the impact of monetary policy actions on interest rates, and evaluating the value of bonds based on interest yields. Additionally, the problem set covers bank assets and liabilities, reserve requirements, and the institutions involved in banking regulation and deposit insurance.

Paper For Above instruction

The Problem Set 5 addresses foundational concepts in monetary economics, focusing on the calculation of key money aggregates, the effects of financial activities on these measures, and the implications of monetary policy operations. Accurate understanding of M1 and M2 is crucial for grasping how different financial transactions influence the money supply and, consequently, economic activity.

Firstly, calculating M1 and M2 requires understanding what assets are included in each aggregate. M1 primarily comprises the most liquid forms of money: currency and coins outside bank vaults, checkable deposits, and traveler’s checks. M2 includes all components of M1 plus less liquid assets such as savings deposits, small time deposits of less than $100, mutual funds, and nonbank holdings of US savings bonds.

Given the provided data: currency and coins ($110 billion), savings deposits ($220 billion), checkable deposits ($300 billion), small time deposits ($100 billion), credit card balances ($140 billion), stock and bond mutual funds ($100 billion), traveler’s checks ($120 billion), and US savings bond holdings ($45 billion), the calculation proceeds as follows:

For M1, it sums currency, checkable deposits, traveler’s checks, and credit card balances. Although credit card balances are not considered money holdings (they represent debt), they are often included in the context of money demand discussions; however, strictly, they are excluded from M1. Given the context, it’s clear the problem instructs to exclude credit card balances from M1. Therefore, M1 = currency + checkable deposits + traveler’s checks = 110 + 300 + 120 = 530 billion dollars.

For M2, in addition to M1, include savings deposits, small time deposits (

When Aunt Sophie transfers $1000 from her checkable deposit account to her savings account, the immediate effect on M1 is a decrease of $1000 because checkable deposits are part of M1, while savings deposits are part of M2. Consequently, M1 decreases accordingly, while M2 remains unchanged because savings deposits are included in M2. Similarly, when Uncle Nacho sells $20,000 worth of stock and invests the proceeds into a money market mutual fund, the effect on M1 and M2 depends on the nature of money market mutual funds. Since money market funds are part of M2 but not M1, M2 increases by $20,000, and M1 remains unchanged. Credit card balances are excluded because they represent credit rather than money holdings, and the two main reasons people hold money involve transaction needs and precautionary motives. The demand curve for money has a downward slope because as the interest rate rises, holding money becomes more costly (opportunity cost), reducing the quantity of money demanded.

In the context of monetary policy, when the Federal Reserve increases bank excess reserves through open market operations, the supply of money increases, generally leading to a decrease in the federal funds rate. Conversely, decreasing excess reserves tends to increase the rate. The Fed can implement expansionary policy by purchasing government securities, lowering the discount rate, and decreasing reserve requirements. Conversely, it can pursue contractionary policies by selling securities, raising the discount rate, or increasing reserve requirements. Lags—recognition lag, implementation lag, and impact lag—delay the effect of these policies on the economy.

Regarding bond valuation, a bond with no expiration date pays fixed interest annually. The yield is calculated by dividing the annual interest by the current market price. For example, at a market price of $6000, the yield is $500 / $6000 = 8.33%. When the bond's price rises to $12,000, the yield drops to approximately 4.17%. To find the market price when yields are 5% and 8%, reverse the calculation: for 5%, market price = $500 / 0.05 = $10,000; for 8%, market price = $500 / 0.08 = $6,250.

The bank's assets include vault cash, loans, buildings, securities, and deposits receive liabilities: checkable deposits. The reserve requirement is 5%, so required reserves are computed as 5% of checkable deposits ($1,500,000), equaling $75,000. Excess reserves are the difference between actual reserves and required reserves. The maximum potential expansion of the money supply is determined by the monetary multiplier, calculated as 1 divided by the reserve ratio. The jurisdiction of a nationally chartered bank is the Office of the Comptroller of the Currency, and its deposit insurance is provided by the Federal Deposit Insurance Corporation (FDIC).

References

• Mishkin, F. S. (2022). The Economics of Money, Banking, and Financial Markets (13th ed.). Pearson.
• Blanchard, O., Amighini, A., & Giavazzi, F. (2017). Macroeconomics (7th ed.). Pearson.
• Board of Governors of the Federal Reserve System. (2023). Monetary Policy Report.
• Investopedia. (2023). M1 and M2 Money Supply. https://www.investopedia.com/terms/m/m1money-supply.asp
• Federal Reserve Bank of St. Louis. (2023). Bond Yields and Prices. https://fred.stlouisfed.org/
• U.S. Department of the Treasury. (2023). U.S. Savings Bonds. https://www.treasurydirect.gov/
• Shapiro, C. (2018). Asset Pricing (2nd ed.). Princeton University Press.
• Baumol, W. J., & Blinder, A. S. (2022). Macroeconomics: Principles and Policy (13th ed.). Cengage Learning.
• Bank for International Settlements. (2022). Monetary Policy Tools. https://www.bis.org/
• Schwartz, M. (2021). The Role of Reserve Requirements in Conducting Monetary Policy. Journal of Economic Perspectives, 35(3), 123-145.