1. Suppose that currency in circulation is $600 billion, the amount of checkable deposits is $900 billion, excess reserves are $15 billion, and the required reserve ratio on checkable deposits is 10%.
a. Calculate the money supply, the currency deposit ratio, the excess reserve ratio, and the money multiplier.
b. Suppose the central bank conducts an unusually large open market purchase of bonds held by banks of $1,400 billion due to a sharp contraction in the economy.
Assuming the ratios you calculated in part a are the same, what do you predict will be the effect on the money supply?
c. Suppose the central bank conducts the same open market purchase as in part b, except that banks choose to hold all of these proceeds as excess reserves rather than loan them out, due to fear of a financial crisis. Assuming that currency and deposits remain the same, what happens to the amount of excess reserves, the excess reserve ratio, the money supply, and the money multiplier?
d. Following the financial crisis in 2008, the Federal Reserve began injecting the banking system with massive amounts of liquidity, and at the same time, very little lending occurred. As a result, the M1 money multiplier was below 1 for most of the time from October 2008 through 2011. How does this relate to your answer to part c?
2. What does the Taylor rule imply that policymakers should do to the fed funds rate under the following scenarios?
a. Unemployment rises due to a recession.
b. An oil price shock causes the inflation rate to rise by 1% and output to fall by 1%.
c. The economy experiences prolonged increases in productivity growth while actual output growth is unchanged.
d. Potential output declines while actual output remains unchanged.
e. The Fed revises its (implicit) inflation target down.