The Required Reserve Ratio Increases

Published Date: 02 Nov 2017

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1. Consider the following quote:

"The Fed has sharply increased its purchases of Treasury securities, apparently to allow for more borrowing in the private sector and help encourage the economy. ... [A] growing number of economists view the Fed's willingness to take on more of the debt as inflationary in the long run."

Using what you know about the loanable funds market (pool of funds), determine whether the first part of the statement is accurate. Explain and illustrate.

Answer: As we have learned in a loan-able market how money is fluctuated by savers and borrowers and new capital is generated to bring betterment in the economy. The above mentioned statement is accurate as well because the federal is purchasing more treasury securities so that there is enough supply of money in the private market and the economy flourishes.

Why is there a concern that taking on more of the debt may prove to be inflationary (according to the second part of the statement)? Discuss using the goods and money markets.

Answer: Keeping in view the money market and good markets the statement is not that wrong at concerning how increase purchase of treasury securities will result as a debt that is inflationary, because an economy is in a balance form when the supply of money is equally distributed and both the supply and demand are at an equilibrium point whereas by increasing the supply of money in private sector means more money will be generated by lending it further and getting high interest on it and the unequal distribution and generation of money will end up in increase in the price of goods and services bought and sold by that same money causing inflation in the economy on a long term base.

3. Intuitively explain the effect of the following on the money supply:

a) The transactions cost associated with having a bank account declines.

Answer: if a transaction cost associated with having a bank account declines then the money supply will also decrease and this decrease can also be drastically if the transaction cost is not balanced.

The required reserve ratio increases.

Answer: A rise in the required reserve ratio has a negative effect on the money supply as the banks start to increase their reserve ration and slow the lending process which means decrease the money supply.

The excess reserve ratio declines.

Answer: if the excess reserve ration declines that there will be a reverse scenario, the money supply will now increasing as the firms and banks will be allowed to give out more loans.

The public feels that the banking system is on the verge of collapsing.

Answer: if that is the case then the money supply in the market will decline rapidly, because the people will withdraw their money from the banks and that will end up in slow or no loans, resulting in no new capital to be generated.

The government cracks down on illegal activities.

Answer: The government has an important role in how the money is being supplied in the market and economy if the government itself cracks down than obviously the public won’t have trust in any institution and the money will be reserved personally.

6. Carefully explain the circumstances under which an expansionary monetary policy may bring about higher nominal interest rates. What should be the state of the economy at the time that the monetary policy was implemented for such result to occur? Hint: make use of the concept of expected inflation in the money market.

Answer: An expansionary monetary policy is a policy adopted to increase the supply of money through buying government bonds an open market purchase, lower the discount rate and lower the reserve ratio. An increase in the money supply causes interest rates to fall the decrease in interest rates causes consumption and investment spending to rise and so aggregate demand rise the increase in aggregate demand causes real GDP to rise

But as increase in money brings increase in price which then when a point comes that the value of money starts falling can result in decrease in demand and purchasing power and the economy faces a situation where too bring equilibrium the interest rate is increased so that the money supply is balanced and the value of money does not fall.

8. Explain whether the following could result from an expansionary monetary policy followed by the Fed. Be sure to describe the economic circumstances that would determine the outcome:

a. mortgage rates would decline.

Answer: by an expansionary monetary policy the banks and institutions will be lending more loan which means more people will be able to own homes and the crisis of mortgage would be faced soon which will cause an sinking of the housing market.

b. the rate that short-term treasury bonds pay would decrease.

Answer: In a short term treasury bond, an increase in the money supply will push the interest rate down as the demand of money would be fluctuating and it will modify people's desire for liquid property and thus the prices and rates of return on bonds.

c. stock market would rise

Answer: the expansionary monetary policy means an increase in the rate of money supply which than supports the rate of increase in stock prices and rises in stock prices provides an incentive to liquidate long-term saving deposits. And thus the received money is then used in buying stocks and other financial property that acts as an asset. While in this process demand deposits leans to increase, which results in raise in money.

9. Explain to someone who knows little about economics the following statement:

a. "the Fed should be ready to reverse its recent interest rate cuts if the economy escapes major damage from the recent housing turmoil."

Answer: Due to the Federal new interest rate policy if the economy is suffered by the housing turmoil meaning the market confusion and disturbance the federal should be prepared to change their policy and stabilize the economy by a balanced money supply and a balanced interest rate policy.