Problem Set 4

Problem Set 4
1. What determines whether a financial asset is included in the M1 money supply? Why are interest-earning checkable deposits included in M1, whereas interest-earning savings accounts and Treasury bills are not?
a. Any financial asset that can be easily changed into physical money is included in the M1 money supply.
b. Because checkable deposits are easily changed into physical money, they are included in M1; however, savings accounts and Treasury bills cannot be, due to the fact that they are short-term investments with time limits.

2. Why are banks able to maintain reserves that are only a fraction of the demand and savings deposits of their customers? Is your money safe in a bank? Why or why not?
a. Banks only need to maintain reserves for checking accounts, allowing the banks to make savings accounts harder to withdraw from if the bank is running low on reserves.
b. Because of the establishment of the Federal Deposit Insurance Corporation, money is safe in the bank for up to $250,000 per account.

3. What is the Federal Funds Interest rate? If the Fed wants to use open market operations to lower the federal funds rate, what action should it take?
a. The Federal Funds Interest Rate is the rate that banks that have lended pay back to the banks that they borrowed from.
b. If the Fed wants to use open market operations to lower the federal funds rate, the Fed should sell securities and collect from owed accounts.

4. Suppose that the reserve requirement is 10 percent and the balance sheet of the People's National Bank looks like the accompanying example.

a. What are the required reserves of People's National Bank? Does the bank have any excess reserves?
Because the reserve requirement is 10% and the People’s National Bank has $120,000 in loan assests, it is required that they have $12,000 in reserves. Because the bank has $50,000 (vault cash + deposits at Fed) in actual reserves, the bank has a total of $38,000 in excess reserves.
b. What is the maximum loan that the bank could extend?
Because the bank has $50,000 (vault cash + deposits at Fed) in reserved, and it has a 10% reserve requirement, the bank could loan a total of $500,00; however, because it already is lending $120,000, it can only loan an additional $380,000, currently.
c. Suppose that the required reserves were 20 percent. If this were the case, would the bank be in a position to extend any additional loans? Explain.
If the required reserves were 20%, then the bank would only be able to loan an additional $130,000

Assets
Liabilities
Vault Cash $20,000
Checking deposits $200,000
Deposits at Fed $30,000
Net Worth $15,000
Securities $45,000

Loans $120,000