QUESTION #1: 6 POINTS a. a. The FED’s sale of bonds decreases MS  increasing N int. rts. b. Nominal  Money Market always N interest c. PL rise or PL fall (change in N to maintain R)

QUESTION #1: 6 POINTS (CONT.) d.Output decreases & PL decreases in SR f. Correct fiscal policy (AD  ): Decrease taxes Increase transfer payments Increase G spending

QUESTION 2: 4 POINTS a.Lower Fed. Funds Rate (lower interest rate)? Buy bonds Price of bonds increase b. N interest rates decrease c. Not affect the level of required reserves…change assets only!!! d. Discount rate: the interest rate that the FED charges banks from borrowing from its discount window b.

QUESTION 3: 5 POINTS a.Reserve requirement = 10% ($10,000/$100,000) b.i. Reserves will change $5,000 after the $5,000 withdrawal ii. No effect on M1 money supply. M1 is comprised of cash and checkable deposits. It’s simply a transfer of the form M1 is taking. iii. Excess reserves = $500 ( RR =$9,500; Loans = $85,000. $9,500 + $85,000 = $94,500. DD = $95,000; $95,000−$94,500 = $500) Reserves MUST = Demand deposits

C-7: STATE IMPLICATIONS OF FED EXPANSIONARY/CONTRACTIONARY MONETARY POLICY ON GDP & PL QUANTITY THEORY OF MONEY

COPERNICUS’S MONETAE CUDENDAE RATIO (1526) King Sigismund I of Poland asked him to offer proposals for reform of the tangled currency of the area. Since the 1460s, Prussian Poland, where Copernicus lived, was the home of three different currencies: that of Royal Prussia, the Polish kingdom itself, and that of Prussia of the Teutonic Order. None of the governments maintained a single standard of weight. The Teutonic Order, in particular, kept debasing and circulating cheaper money.

“THE QUANTITY THEORY OF MONEY” Theory that prices vary directly with the supply of money in the society The causal chain began with debasement, which raised the quantity of the money supply, which in turn raised prices. The supply of money, he pointed out, is the major determinant of prices. "We in our sluggishness," he maintained, "do not realize that the dearness of everything is the result of the cheapness of money. For prices increase and decrease according to the condition of the money.” "An excessive quantity of money," he opined, "should be avoided.” WHY?????

EQUATION OF EXCHANGE MV = PQ M: money supply V: velocity of money The average number of times per year a dollar is spent on final goods and services P: price level Q: physical volume of all goods and services produced MV (left side of equation) = total expenditure of buyers of output within the given time frame PQ (right side) = total amount received by sellers of output

STABLE ECONOMY M x V = GDP nominal (P x Q)  $ spent = $ value of output RULE THAT MUST BE TRUE!!! Therefore, M (money supply) and GDP nominal are directly related in a predictable fashion Example: M increases of $10 B would upset Equation’s equilibrium (looks like people having more $ in wallets than they want, so households look to spend)  M x V = P x Q; M increase of $10 B will increase P or Q or some combination of both. If M decreases 10%, P/Q decrease 10%

VELOCITY OF MONEY Assumed velocity of money is stable in an economy Times a dollar is spent in a given year Historically: velocity has increased—shorter pay periods, use of credit cards, faster means of making payments V increases then M must decrease to maintain equation of exchange balance over time Factors affecting velocity change gradually over time and can be anticipated V = GDP Nominal (P x Q)/M Stable velocity of money is what allows us to analyze how changes in the money supply affect GDP Nominal See velocity of money for yourself:

BIG IDEA Supply of money directly impacts price level and/or output in an economy Increase in M = increase in P and/or Q (GDP Nominal ) Decrease in M = decrease in P and/or Q (GDP Nominal ) Now, complete Activity 4.8…