Posted: August 4th, 2022

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Economics 350 Student Name:

Spring 2014 ID #:

Homework #4

Due: Thursday, April 17 in class

Total Points Available: 40

Question 1. Consider whether the following statements (taken from questions in the Mishkin

textbook) are true, false or uncertain. In each case, provide a brief explanation.

a. (2 points) Question 19.18: “If the demand for reserves did not fluctuate, the Fed could
pursue both a reserves target and an interest-rate target at the same time.”

b. (2 points) Question 18.16: “If reserve requirements were eliminated, it would be harder
for Fed to control interest rate[on federal funds]. ”

c. (2 points) Question 15.11: “Conflicts of interest always reduce the flow of reliable
information.”

d. (2 points) (Adapted from question 17.14.): “In October 2008, the Federal Reserve began
paying interest on the amount of excess reserves held by banks. Money multiplier

increased as a result of this.”

Question 2. Assume that for an annual premium of $20 the federal government will provide

any homeowner with earthquake insurance. Moreover, this insurance has a $0 deductible,

in that the government will pay the entire cost of repairing or replacing structures

damaged by earthquake. Finally, suppose that the government monitors its insurees to

confirm that their claimed damages are in fact earthquake-related (so fraud is not an

issue). (Also assume that there is no other provider of earthquake insurance.)

a. (2 points) What effect would this insurance have on the behavior of homeowners in
earthquake-prone areas? Do you expect the government’s insurance to increase or

decrease the number of houses in these regions?

b. (2 points) Suppose the federal government decides to improve its insurance system by
changing the fee structure of the insurance. How should it modify its fees?

c. (2 points) List at least two other modifications to this insurance system that would help
the government better handle the problems of asymmetric information that it faces.

Question 3. (3 points) Suppose that the Federal Reserve’s balance sheet contains:

Total assets (with float appearing as an asset) = $1200

Treasury deposits = $60

Other Federal Reserve liabilities and capital accounts = $80

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In addition, suppose that Treasury currency in circulation totals $70, and that the money

multiplier is 1.6. What is the money supply?

Question 4. (3 points) Suppose the required reserve ratio were 8 percent of checkable

deposits, and the simple deposit multiplier applied. Using negatives to represent a

decrease, if the Fed bought $480 of Treasury securities from a bank, the result would be a

$________ increase in reserves, a $______ increase in excess reserves, and a $________

increase in checkable deposits. (Your answer should be for the entire banking system.)

Question 5. Consider an economy with the following quantities:

i. C = currency in circulation = $6,750

ii. D = checkable deposits

iii. c = C/D = currency-deposit ratio

iv. e = ER/D = excess reserves-deposit ratio = 0.01

v. r = required reserve ratio = 0.05

vi. RR = r⋅D = required reserves
vii. M = money supply (M1) = C + D

viii.R = RR + ER = total reserves = $900

ix. MB = monetary base = C + R

x. m = (M1) money multiplier = M/MB

a. (1 point) What are deposits, D?

b. (3 points) Using your answer to part (a), find excess reserves, ER, currency, C and
currency-deposit ratio, c .

c. (1 point) What is the monetary base, MB?

d. (2 points) Using your answer to parts (a) and (b), find M.

e. (2 points) Using e, r and c, find m.

f. (2 points) Without using e, r and c, find m again.

Question 6. (Mishkin, question 17.12.) What effect might a financial panic have on the

money multiplier and money supply? Why ?

Question 7. For each of the following events, answer the following: (1) How would this

event affect the money supply? (2) What sort of defensive open market operation would

the Fed undertake in response?

a. (2 points) Mardi Gras celebrations lead people to carry more cash.

b. (2 points) In late March, the Treasury deposits its newly-collected tax revenues at the

Federal Reserve.

Question 8. (3 points) Find M1 and the monetary base MB data for the month of February,

2014, available from the Board of Governors of the Federal Reserve System. This data

can be found on the Board’s web site, under separate releases[H.3 & H.6]: please use not-

seasonally-adjusted data. What is the M1 money multiplier? (Warning: pay attention to

the units!)

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