Question.105 - Please use a word processor such as Microsoft Word, Apple Pages or OpenOffice for your answers. If you have trouble editing the graphs, you can also sketch them on paper, take pictures of them and then insert the pictures in your file. Please make sure that the graphs are readable. Also please also print your file to pdf and attach both files (e.g. the Word file and the pdf file, which is just a print of the Word file). PDF is more stable and readable independently from the source file. 1) Suppose that the Fed purchases from bank B some bonds in the open market and that, before the sale of bonds, bank B had no excess reserves.a) Describe what initially happens to the reserves of bank B.b) If bank B does not want to hold excess reserves, what will it do with the additional money received from the sale of bonds to the Fed?c) Why do we expect, at least in usual times, that the amount of checking deposits in the economy will go up? Describe briefly the various “rounds” of this process.d) Now suppose that minimum required reserve ratio for banks is 1/10. Also suppose that banks hold no excess reserves and that currency in circulation is unchanged from the purchase of bonds. If the Fed buys $20 billions of bonds from bank B, what will be the increase in checking deposits? 2) Describe in one or two sentences what the Fed funds rate is.b) Suppose that, some years from now, the Fed funds rate is 4% and that you are considering buying a car. You also intend to finance the purchase with a loan. Suppose that the Fed increases the Fed funds rate to 4.5% by selling bonds on the open market. Financially, is this a good news for you or not? Explain why.3) a) Suppose that the face value of a 1-year bond is $100 and that no coupons are paid during the year. Suppose also that the price of the bond is $96. What is the yield of this bond approximately?b) Suppose that the face value of a 1-year bond is $100 and that no coupons are paid during the year. Suppose also that the yearly yield of this bond is 5%. What is approximately the price of the bond?c) Suppose that the face value of a 2-year bond is $100 and that no coupons are paid during the two years. Suppose also that the yearly yield of this bond is 5%. What is approximately the price of the bond?d) In b) and c) above the two bonds have different maturity but identical yield. Why do we usually think that the bonds with longer maturities will give higher yields? 4) a) Suppose that AD is strong because of high consumers and business optimism. For this reason, unemployment is below NAIRU. Represents this situation using an AS/AD graph (do not forget to distinguish between SRAS and LRAS).b) The Fed is concerned that this overheated economy will put pressure on prices and lead to a too high level of inflation. For this reason the Fed wants to engage in contractionary monetary policy, reducing AD, and so output, thereby increasing unemployment. What do you expect the Fed will do, sell Treasury bonds or buy Treasury bonds?c) Represent on a graph the effect of the Fed’s policy on the Fed funds rate. The graph should have the Fed funds rate on the vertical axis and it should clearly distinguish the old and the new equilbrium value of the Fed funds rate.d) Which components of AD does the Fed try to affect and how? 5) a) Draw a supply-demand diagram of the foreign exchange market for the dollar (valued in “euros”). Who demands dollars? Who supplies dollars?b) If, in more usual economic times (rather than a deep recession), the Fed were to announce an increase in the Fed funds rate, what would you expect to happen to the value of the dollar? Show your answer on the graph and briefly explain it. 6) a) U.S. payroll taxes were reduced in 2003. This reduction was temporary and due to expire at the end of 2010. In 2010 Congress decided to extend these cuts for two years. One of the rationale for this was that increasing taxes would have deepened the economic difficulties of the country. Make sense of this argument using the AS/AD framework (you can also use a graph here but you do not need to).b) In 2012 the Congress made these tax cuts permanent except for high incomes (more than $400,000 per year if single and more than $450,000 per year if married) whose taxes were increased. Explain why supply-siders would disagree with increasing the taxes on high-income individuals.Please use a word processor such as Microsoft Word, Apple Pages or OpenOffice for your answers. If you have trouble editing the graphs, you can also sketch them on paper, take pictures of them and then insert the pictures in your file. Please make sure that the graphs are readable. Also please also print your file to pdf and attach both files (e.g. the Word file and the pdf file, which is just a print of the Word file). PDF is more stable and readable independently from the source file. 1) Suppose that the Fed purchases from bank B some bonds in the open market and that, before the sale of bonds, bank B had no excess reserves.a) Describe what initially happens to the reserves of bank B.b) If bank B does not want to hold excess reserves, what will it do with the additional money received from the sale of bonds to the Fed?c) Why do we expect, at least in usual times, that the amount of checking deposits in the economy will go up? Describe briefly the various “rounds” of this process.d) Now suppose that minimum required reserve ratio for banks is 1/10. Also suppose that banks hold no excess reserves and that currency in circulation is unchanged from the purchase of bonds. If the Fed buys $20 billions of bonds from bank B, what will be the increase in checking deposits? 2) Describe in one or two sentences what the Fed funds rate is.b) Suppose that, some years from now, the Fed funds rate is 4% and that you are considering buying a car. You also intend to finance the purchase with a loan. Suppose that the Fed increases the Fed funds rate to 4.5% by selling bonds on the open market. Financially, is this a good news for you or not? Explain why.3) a) Suppose that the face value of a 1-year bond is $100 and that no coupons are paid during the year. Suppose also that the price of the bond is $96. What is the yield of this bond approximately?b) Suppose that the face value of a 1-year bond is $100 and that no coupons are paid during the year. Suppose also that the yearly yield of this bond is 5%. What is approximately the price of the bond?c) Suppose that the face value of a 2-year bond is $100 and that no coupons are paid during the two years. Suppose also that the yearly yield of this bond is 5%. What is approximately the price of the bond?d) In b) and c) above the two bonds have different maturity but identical yield. Why do we usually think that the bonds with longer maturities will give higher yields? 4) a) Suppose that AD is strong because of high consumers and business optimism. For this reason, unemployment is below NAIRU. Represents this situation using an AS/AD graph (do not forget to distinguish between SRAS and LRAS).b) The Fed is concerned that this overheated economy will put pressure on prices and lead to a too high level of inflation. For this reason the Fed wants to engage in contractionary monetary policy, reducing AD, and so output, thereby increasing unemployment. What do you expect the Fed will do, sell Treasury bonds or buy Treasury bonds?c) Represent on a graph the effect of the Fed’s policy on the Fed funds rate. The graph should have the Fed funds rate on the vertical axis and it should clearly distinguish the old and the new equilbrium value of the Fed funds rate.d) Which components of AD does the Fed try to affect and how? 5) a) Draw a supply-demand diagram of the foreign exchange market for the dollar (valued in “euros”). Who demands dollars? Who supplies dollars?b) If, in more usual economic times (rather than a deep recession), the Fed were to announce an increase in the Fed funds rate, what would you expect to happen to the value of the dollar? Show your answer on the graph and briefly explain it. 6) a) U.S. payroll taxes were reduced in 2003. This reduction was temporary and due to expire at the end of 2010. In 2010 Congress decided to extend these cuts for two years. One of the rationale for this was that increasing taxes would have deepened the economic difficulties of the country. Make sense of this argument using the AS/AD framework (you can also use a graph here but you do not need to).b) In 2012 the Congress made these tax cuts permanent except for high incomes (more than $400,000 per year if single and more than $450,000 per year if married) whose taxes were increased. Explain why supply-siders would disagree with increasing the taxes on high-income individuals.
Answer Below:
a xxxxxxxxx to xxx Fed xxxxxxx requirements xxx the xxxxx have xx keep x certain xxxxxxxxxx of xxx public xxxxxxxx in xxx form xx government xxxxx and xxxxxxxxxx These xxxxxx as xxxxxxxx on xxx liabilities xxxx of xxx bank x balance xxxxx Barring xxxx amount xx funds xxx banks xxx use xxx balance xx the xxxxxx deposits xx make xxxxx and xxxx interest xxxx Fed xxxxxxxxx the xxxxx from xxxx B xx creates xxxxxxxxxx reserve xxxxxxxx the xxxxxx paid xx the xxx to xxx bank xxxxx the xxxx did xxx have xxx excess xxxxxxxx earlier x e xx had xxxxxxxx all xxx lendable xxxxxxx of xxx reserves xx the xxxx of xxxxx it xxxx now xxxx additional xxxxxxx to xxxx loans xxx thereby xxxx additional xxxxxxxx Hence xxxxxx of xxxxx by xxx leads xx creation xx additional xxxxxxxx with xxxx B x When xxx Fed xxxxxxxxx bonds xxxx bank x it xxxxxxx the xxxxxxxxxx securities xxxx by xxxx B xxx simultaneously xxxxxxxxx its xxxxxxxx Since xxx bank xxx no xxxxxxxxxx reserves xxxxxxxxxx hence xxxxxxx of xxxxx to xxx results xx additional xxxxxxxx As xxx bank xxxx not xxxx to xxxx the xxxxxxxxxx reserves xx will xxx it xx make xxxxx to xxxxxxxxxxx or xxxxxxxxxx and xxxx more xxxxxxxx As xxx increase xx reserves xxx been xxx to xxxx of xxxxx b xxx bank xxx not xxxxxxx accumulation xx public xxxxxxxx hence xxxx B xxxx be xxxx to xxx the xxxxxx amount xx the xxxxx transaction xx make xxxxx If xxx banks xxxxxxxxx its xxxxxxxx through xxxxxxx of xxxxxx deposits xxxx it xxxxx have xxxx bound xx keep x certain xxxxxxx of xxx raised xxxxxxxx in xxx form xx non xxxxxxxx reserves x Checkable xxxxxxxx are xxxxx deposits xx financial xxxxxxxxxxxx against xxxxx checks xx drafts xxx be xxxxxxx When xxx bus xxxxx from xxx open xxxxxx then xx creates xxxxxxxxxx cash xxxx the xxxxx businesses xxxxxx and xxx local xxxxx These xxxxxxxxxxx small xxxxxxxxxx and xxx local xxxxx then xxxx the xxxxxxxxxx cash xxxxxxx to xxx to xxxxx existing xxxxxxxxx deposits xxx to xxxxxx new xxxxxxxxx deposits xxxx the xxxxxxxxx institutions xxxx action xxxxxxx in xxxxxxxx in xxx deposits xx these xxxxxxxxx institutions xxxxx the xxxxxxxx of xxx financial xxxxxxxxxxx increases xxxxx the xxxx create xxxxxxxxxx reserves xxx the xxx deposits xxx the xxxx of xxx deposits xxxx be xxxx b xxxx to xxxx loans xx businesses xx individuals xxxxx purchase xx bonds xx the xxxx market xxxxx to xxxxxxxx of xxxxx supply xx the xxxxxx d x Fed xxxx rate xx the xxxx at xxxxx the xxxxxx worth xxxxxxxxx institutions xxxx fund xx other xxxxxx noted xxxxxxxxx institution xxxxxxxxx in xxxxx to xxxxxxx the xxxxxxxxx reserve xxxxxxxxxxx to xx held xx the xxxxxxx accounts xx such xxxxx It xx the xxxx rate xx interest xxx the xxxxxxxxx institutions xx it xxxxxxxxxx the xxxx of xxxxxxxxx borrowed xxxxx of xxx financial xxxxxxxxxxxx b xxx fund xxxx is xxx primary xx the xxxx rate xx it xxxxxxxxxx the xxxx of xxxxxxxxx funds xxxxxxxx b x financial xxxxxxxxxxx and xxxx cost xx funds xx then xxxxxxxxxxx to xxx loans xxxx b xxxxx financial xxxxxxxxxxxx to xxxxx smaller xxxxxxxxxxxx banks xx individuals xxxx rate xx set x the xxxxxxx Open xxxxxx Committee xx a xxxx of xxxxxxxx tool xx maintain xxx money xxxxxx in xxx economy xxxx the xxxx increases xxx fed xxxx rate xx results xx higher xxxx of xxxxx for xxx borrowing xxxxxxxxx institutions xxxxx an xxxxxxxx of xx the xxx fund xxxx increases xxx base xxxx b xxx it xxxx transferred xx the xxxxxxxxxx borrowing xxxx in xxx market xx increase xx the xxx fund xxxx is xxxxxxxxxxx a xxx news xxx individuals xx businesses xxxxxxx loan x Face xxxxx of xxxx Price xx the xxxx Coupons xx the xxxxxxx of xxxxxx payments xxx formula xxx the xxxxx of xxx bond xx as xxxxxxx Price xx bond xxxx Value x t xxxxx r xxxxx to xxxxxxxx per xxxxxx and x the xxxx maturity xxxxxxxxxxx according xxx given xxxxxxx r xx r xxx b xxxx value xx the xxxx coupons xxxxxx year xxxxxx yield xxxx implies xxxxx of xxxx Face xxxxx r x Where x yield xx maturity xxx period xxx t xxx bond xxxxxxxx periodHence xxxxxxxxx the xxxxx problem xx price xxx c xxxx value xx bond xxxxx to xxxxxxxx yearly xxxxx coupon xxxxx of xxxx Face xxxxx r x Where x yield xx maturity xxx period xxx t xxx bond xxxxxxxx periodHence xxxxxxxxx the xxxxx problem xx price xxx d xxxxx with xxxxxx maturities xxxx to xxxx higher xxxxx as xx the xxxx run xxx risk xx the xxxxxxx in xxx expectations xxxxxxxxxx with xxxxxxxxx and xxxxxxxx rates xxx higher xx compared xx short xxxx When xxxxxxxxxxxx for xx increase xx inflation xxxxx rise xx results xx the xxxxxxxx in xxx interest xxxxx These xxxxx are xxx prevailing xxxxx at xxxxx the xxxxx are xxxxxxxxxx for xxx cash xxxxx it xx the x in xxx formula xxxx in xxx above xxxxxxxx Hence xx increase xx interest xxxx in xxx long xxx will xxxxxx in xxxxxxxx in xxx yield xx the xxxxx and xxxxxxxx in xxx prices xx bonds xx bond xxxxxx are xxxxxxxxx related xxx the xxxx run xxxxx curve xx the xxxxxxxxx representation xx the xxxxxxxxx interest xxxx expectations x Look xx the xxxxxxxx belowIn xxx above xxxxx the xxxxxxxxx demand xxx increased xxxx AD xx AD xxxxxx increasing xxx price xx P xxxx increase xx the xxxxxx increases xxx employment xxxxx in xxx econom xx the xxxxx run xxx the xxxxxxxxxxxx rate xxxxxxxxx lower xxxx the xxx accelerating xxxx of xxxxxxxxxxxx which xxxxxxxx that xxxx a xxxxxx rate xx inflation xxx unemployment xxxx will xx consistent xxx in xxx short xxx when xxx increase xx the xxxxxxxxx demand xxx et xxx affected xx increase xx the xxxxx the xxxxxxxxxxxx rate xxxxx below xxx NAIRU xx depicted xx the xxxxx below xxxx the xxxxxxxxxxxx rate xxx fallen xx U xxxx the xxx accelerating xxxx of xxxxxxxxxxxx of x In xxx long xxx however xxx wages xxxxxxxxx thereby xxxxxxx to xxxxxxxx in xxx unemployment xxxx back xx U xxx at xxxxxx wages x in xxxxx to xxxxx out x contractionary xxxxxxxx policy xxx Fed xxxx have xx reduce xxx money xxxxxx from xxx market xxxxx can xx done x selling xx treasury xxxxx in xxx open xxxxxx When xxx sells xxxxxxxxxx bonds xx the xxxx market xx will xxxx out xxxxx from xxx market xxxxx will xx turn xxxxxxxx the xxxxxxxx rates xxx thereby xxxxxxxxx Such xxxxxx cost xx funds xxxx reduce xxx aggregate xxxxxx and xxxxxx inflation xxxx bring xxxx the xxxxxxxxxxxx rate xxxx at xxx non xxxxxxxxxxxx rate xx unemployment xxxx fall xx unemployment xxxx below xxxxx is xxx a xxxxx span xxxxx inflation xxxxxxxxx this xxxx c xxx equilibrium xx the xxx fund xxxx is xxxxxxxxxx through xxx demand xxx reserve x the xxxxx as xxx fund xxxx is xxx cost xx borrowing xxxxx by xxxxxxxxx institutions xx an xxxxxxxxx basis xxxx Fed xxxxx government xxxxx in xxx open xxxxxx the xxxxx businesses xxxxxxxxxxx and xxxxxx will xxxxxxxx their xxxx portion xx deposits xxxx the xxxxx which xxxx would xxx in xxxxxxxxxx the xxxxx This xxxx in xxxx cause xxx banks xx either xxx the xxxxxx from xxx reserves xx b xxxxxxx ineterest xxx principal xx loans xxxxxxx creating xxxxxxxx of xxxxxxxx for xxx banks xxxx demand xxx reserves xxxx be xxxxxxx b xxx banks xxx will xxxxxx more xxx to xxxxxxxx their xxxxxxx requirements xxx such xxxxxx will xxxx the xxx fund xxxx higher xxxxxxxx a xxx fed xxxx rate xxxxxxxxxxx As xxxxx in xxx graph xxxxx the xxxxxx for xxxxxxx will xxxxxxxx from xxxxx at xxxxxxxx rate x ff xx a xxxxx higher xx interest xxxx i xx d xxx contractionary xxxxxxxx policy xxxxxxx b xxx will xxxxxx money xxxxxx from xxx economy xxxxx will xxxxxxxx the xxxx rate xxx therefore xxx market xxxxxxxx rate xx the xxxxxx Such xxxxxxxx in xxx interest xxxx will xxxx the xxxxxx demand xxxx loans xxxx the xxxxx also xxx inflation xxxx will xxxxxxxx thereby xxxxxxxxxx the xxxx of xxxxxxxxxxx Hence xxxxxx interest xxxxx will xxxxxxx the xxxxxxxxxxx expenditure xxxxx is xxx most xxxxxxxxx component xx aggregate xxxxxx a xxx exchange xxxx between xxx currencies xx determined x the xxxxxxxxxxxxx equilibrium xxx the xxxxxxxx in xxx foreign xxxxxxxx market xxx dollars xxxx be xxxxxxxx in xxxxxx by xxxxxx of xxxx country xxx wants xx purchase xx goods xxxxx shares xxxx assets xxx etc xxx supply xx dollars xxxx be xxxxxxxx by xxxxx people xx the xxxxxxx who xxxx to xxx imported xxxxx US xxxxxx who xxxx to xxx bonds xxxxxx and xxxxx real xxxxxx As xxxxx below x show xxxxxx for xxxxxx and xx showed xxx supply xx dollars xx terms xx Euro xxx demand xxx supply xxxx intersect xx the xxxx of xxxx dollar x when xxx fed xxxxx rate xx increased x the xxx the xxxxxxxx rate xx the xxxxxxx rises xxxx increase xx the xxxxxxxx arte xx the xx economy xxxx attract xxxxxxx investors xx their xxxxxxxxxxx would xxxxx higher xxxxxxx on xxxxxx interest xxxxx Hence xxxxxx for xxxxxx will xxxxxxxx causing xxx euro xxx dollar xxxxxxxx rate xx increase xxxx implies xxxx dollar xxxx strengthen xxxxxxx euro xxx now xxxx Euros xxxx be xxxxxxxx to xxx dollar xx the xxxxxxxx graph xxx demand xxxxx for xxxxxx has xxxxxxx right xx indicate xxxxxxxx in xxxxxx for xxxxxxx in xxx European xxxxxx due xx increase xx interest xxxxx As xxxx in xxx above xxxxx the xxxxxxxx in xxxxxx for xxxxxxx has xxxx the xxxxxx curve xxx dollars xx shift xxxx D xx D xxx shifting xxx exchange xxxx from x to x which xx the xxx exchange xxxx equilibrium x The xxxxxxxxx of xxx payroll xxxxx during xxx recession xxx done xx help xxxxxx with xxxxx annual xxxxxx of xxx annum xx sustain xxxxxx the xxxxxxxxx leading xx an xxxxxxxx in xxxxx salary xxxx provided xxx consumers xxxx additional xxxxx during xxx recession xxx helped xxxx carry xxx consumption xxxxxxxxxxxx This xxxxxx the xxxxxxx to xxxxxx the xxxxxxx in xxx aggregate xxxxxx in xxx economy xxx helped xxxxxxxxxx of xxxxx to xxx their xxxxxxxx and xxxx Repayment xx interest xxx debt xxxxxxx money xx the xxxxxxx system xxx hence xx the xxxxxx However xxxxx taxes xxxxxxxx in xxxx of xxx revenues xxx the xxxxxxxxxx and xxx government xxxxxxxx on xxx social xxxxxxxx services xxxxxxxxx The xxxxx payroll xxx also xxxxxxx lower xxxxx paid x the xxxxxxxx and xxxxxxx resulting xx lower xxxx costs xxxxx wage xxxxx would xxxx the xxxxxxxxx to xxx their xxxxxxxx during xxxxxxxxx and xxxx the xxxxxxx from xxxxxxx threats xx unemployment xxxx would xxxxxx in xxxxxxxxxxx the xxxxxxxxx supply xx the xxxxxxx through xxxxxxxxx of xxxxxxx Hence xxxxxxxxx of xxxxxxx taxes xx the xxxxxxxxxx was xxxx a xxxx to xxxxxxxxx demand xxx money xxxxxx in xxx economy xxxxx on xxx other xxxx it xxxxx have xxxxx the xxxxxxx from xxxxxxx unemployment xxx reduced xxxxxx b xxxxxxx taxes xxxxxx the xxxxx or xxxxxxxx income xxxxxx as xxx form x major xxxxx of xxxxx salaries xxx wages xx per xxx tax xxxxx levied xx the xxxxxxx wages xxx salary xxxxxx Hence xxxx taxes xxxxxxxx a xxxxxxx portion xx the xxxxxx income xx the xxxxxx income xxxxx groups xxxx the xxxxxx income xxxxx group xxxxx their xxxx income xxxxxxxxx from xxxxxx share xx profits xxx capital xxxxx over xxxxx there xxx no xxxxxxx taxes xxxxxx Hence xxxxxxx in xxx payroll xxxxx hardly xxxxxx the xxxxxx income xxxxx groupMore Articles From Economics
.ico)
.ico)
.ico)
.ico)
