Emergency please help! MONETARY TRANSMISSION MECHANISM PROBLEMS Where we have th

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Emergency please help!

MONETARY TRANSMISSION MECHANISM PROBLEMS

Where we have the following information:

• The money multiplier is 3.25, or is derived from the formula.

• Interest rates will change by 1.5% for each $65 billion change in the money supply.

• Investment will change by $122 billion for each 2% change in interest rates.

• Income will change by $7 for each $2 change in investment.

• The unemployment rate will change by .46% for each $150 billion change in income, up to a maximum short run change of +1.84%.

• If the change in income exceeds +$600 billion, the effects will be strictly inflationary (if income rises) or deflationary (if income falls). For each additional $150 billion in income, the inflation rate will change by 2.1%.

1. What will be the impact on income, unemployment and inflation if the Fed buys $15 billion worth of bonds?

2. What will be the impact on income, unemployment and inflation if the Fed sells $25 billion worth of bonds?

3. If the Fed wants to raise income by $350 billion, how much should it buy/sell in Treasury bonds?

4. If the Fed wants to lower the unemployment rate by 1%, how much should it buy/sell in Treasury bonds?

5. Recalculate problem #1 where the required reserve ratio is 15%, the desired excess reserve ratio is 5% and the currency ratio is 75%. Let your calculated impact on income and unemployment be the Fed’s targets.

a. Let’s begin this problem again, except that there has been increased pessimism in the market and the following changes have occurred that the Fed didn’t count on, as follows:

• the desired excess reserve ratio rises to 50%.

• the desired currency ratio rises to 100%

• interest only changes by .75% for each $65 billion change in the MS

• investment only changes by $66 billion for each 2% change in interest Calculate the effect of the Fed’s policy.

b. Clearly the Fed didn’t reach its target, so they try again, but with an increase amount of bond purchases of $85 billion. But, once again there has been increased pessimism in the market and the following changes have occurred that the Fed didn’t count on:

• the desired excess reserve ratio rises to 95%.

• the desired currency ratio rises to 125%

• interest only changes by .4% for each $65 billion change in the MS

• investment only changes by $36 billion for each 2% change in interest Calculate the effect of the Fed’s policy.

c. That still didn’t work, so the Fed tries once again. This time they buy even more bonds: $250 billion! Well, that should do the trick. Except now, there have been further changes, representing a wave of optimism, as follows:

• the desired excess reserve ratio falls to 15%.

• the desired currency ratio falls to 60%

• interest only changes by 1.5 % for each $65 billion change in the MS

• investment only changes by $122 billion for each 2% change in interest Calculate the effect of the Fed’s policy.

need help deriving these answers:

Answer Key for Monetary Transmission Problems:

1.  Change in income = +$240.2 b.;  change in unemployment rate (Ur) = -.74%;  no change in inflation
2.  Change in income = -$400.3 b.;  change in Ur = +1.23%;  no change in inflation
3.  To reach target, Fed must buy $21.86 b. of bonds.
4.  To reach target, Fed must buy $20.36 b. of bonds.
5.  Change in income = $136.1 b and in Ur is -.42%
   5a.  With changed values the $15 b. purchase of bonds will change income by +$24.2 and Ur by -.07%; ineffective policy.
   5b.  With the values used in #5a, $85 b. in bond purchases should do the trick.  But, because the values changed again, the change in income was +$33.1 b. and in U was -.10%; again ineffective.
   5c.  With the values used in #5b, buying $250 b. in bonds will get us to the target.  But, the values have changed the opposite way and we get a change in income of +$2,189.7, a change in Ur of -1.84% and a change in inflation of +22.26%.

Explanation / Answer

1) Change in money supply = open market operation*money = 15*3.25 = $48.75 b

Change in interest rates = 1.5/65*change in money supply = 1.125%

Change in investment = change in interest rates * 122/2 = $68.625b

Change in Income = change in investment*7/2 = $240.2b

Change in Unemployment = change in income*0.46/150 = -0.74%

As change in income is less than $600b so no change in inflation

2) Change in money supply = open market operation*money = 25*3.25 = $81.25 b

Change in interest rates = 1.5/65*change in money supply = 1.875%

Change in investment = change in interest rates * 122/2 = -$114.375b

Change in Income = change in investment*7/2 = -$400.3b

Change in Unemployment = change in income*0.46/150 = 1.23%

As change in income is less than $600b so no change in inflation

c) Change in investment = change in income*2/7 = $100b

Change in interest rates = change in investment*2/122 = 1.639%

Change in money supply = change in interest rates*65/1.5=$71.038b

Open market operations = Change in money supply/3.25 = $21.86b So Fed should buy $21.86 b of bonds

4) Change in income = change in unemployment*150/0.46 = $326.087b

Change in investment = change in income*2/7 = $93.168b

Change in interest rates = change in investment*2/122 = 1.527%

Change in money supply = change in interest rates*65/1.5=$66.185b

Open market operations = Change in money supply/3.25 = $20.36b So Fed should buy $20.36 b of bonds

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