(1) Suppose the Fed purchases $5 million in Treasury Bonds from Bank of America. Assume the following: reserve ratio of 10%, total checkable deposits in the US financial system are $1 trillion, total excess reserves held by banks is $50 billion, and total currency in circulation is $750 billion.
(a) Use the money multiplier to calculate the increase in the money supply from Fed’s purchase.
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(b) What would the predicted increase in the money supply be using the simple deposit multiplier?
(2) Equilibrium in the Market for Reserves
(a) Use the following information to draw a figure that shows the equilibrium in the market for reserves: a discount rate of 5%, an interest on reserves is 2%, a total amount of nonborrowed reserves of $100 billion. Label the axes, curves, intercepts, and equilibrium values.
(b) What will happen to the federal funds rate if the Open Market Committee authorizes the NY Fed to purchase $5 billion in Treasury Bills? Explain in words and show graphically using the figure from part (a).
(c) Suppose that the Fed uses nonborrowed reserves as a policy instrument. What does this imply regarding the exact level of nonborrowed reserves in the figure from part (a)? What does this imply about the exact federal funds rate in the figure from part (a)? Explain.
Sample Solution
