MOST IMPORTANTLY HELP WITH NUMBER 3. WE KEEP STRUGGLING TO FIND THE CHANGES IN M

Question

MOST IMPORTANTLY HELP WITH NUMBER 3. WE KEEP STRUGGLING TO FIND THE CHANGES IN M1 AND DD.

1.   Assume initially that:

      Currency = $2,200

      DD = $5,000

      e = .333

      required reserves = $400

      TD = $12,000

      MMMF = $1,400

      Determine the initial levels of: kdd, kM1, kM2, MB, M1, M2, and ER. (1 ea.)

2.   Determine the effect on MB, M1, M2, Currency, DD, ER, RR, TD, kM1, and kM2 if the excess reserves to DD ratio becomes .80. (1 ea.)

3.   Quantify (state value and direction) the open market operation that would be necessary to reverse the change in M1 that occurs in question #2?     (5)

Explanation / Answer

PART 3

M1 = Currency with public + Demand deposit in all banks (e.g. current account, savings account) + other deposits with RBI

M1 = 2200 + 5000

       = 7200

e = .333 (excess reserve to DD ratio)

e = ER/DD

ER = .333*5000

ER = 1665

Now e changes to .80 then,

  e = 1665/DD

1665/.80 = DD

DD = 2081.5

M1 = 2200 + 2081.5

        = 4281.5

Open market operation changes the monetary base. When central bank purchases the securities from banks, the reserves get increased. Now banks will lend this reserves which will generate new sums in the banks. Here, because due to rise in excess reserve to DD ratio M1 has decreased, the government can buy securities from banks which further lead to increase in the M1.

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