The Federal Reserve System - Essay Example

?mac9.11 Contents Answer 3 Answer 2 3 Answer 3 4 Answer 4 4 Answer 6 Answer 2 6 Answer 3 8 Answer 4 8 References 9 Lesson 10 Answer Economists define money as the medium of exchange in the form of coin and bank notes. The use of money lies in the transaction processes in exchange of goods as well as services. Commodity money is treated to be the good whose value serves as the value of money. There is no readily identifiable group of assets which all economists would agree are money. Answer 2 The banks held no deposit reserves and all cash were re-deposited. The deposit creation multiplier will be useful to arrive at the answer. DCM=1/RR=1/.10=10 DMS Therefore total reserves are equal to total money supply. So money supply = 10*12 million=120 million. Alternatively, The formula of geometric progression with a common ratio R which is equal to .90: $12,000,000 + $10,800,000 + $9,720,000 + … $12,000,000 x (1 + 0.90 + 0.81 + 0.6561 + …) $12,000,000 x (1 + 0.90 + 0.902 + 0.903 + …) $12,000,000 x 1/1 – 0.90 = $12,000,000/0.10 = $120,000,000 The chain of deposit creation ends only when there are no more excess reserves to be loaned out, i.e. when the entire $12,000,000 is tied up in required reserves. Therefore, with a reserve ratio of 10%, excess reserves disappear only when checking deposits expand by $120,000,000. At RR=25% DCM=1/.25= 4 DMS= 12million*4= 48 million. At RR=100%. The DMS will be 12 million. Answer 3 The value of M1 is checkable deposits + currency= 743+633= $1376 billion. The value of M2 is M1+ Small time deposits+ Money-market mutual funds held by businesses+ Money-market mutual funds held by individuals+ Savings deposits, including money-market deposit accounts. The value of M2 is 1376+3649+1014+744+1190= $7973 billion. Answer 4 The diagram below shows the structure of the Federal Reserve System. The board of governors are appointed by the President. The function of the component is to oversee the system operations, takes decisions of regulations and sets the target level of requirements. The key monetary policy making body within the system is Federal Open Market Committee. The committee is responsible to seek decisions to stimulate monetary growth with price stability as well as influences the flow of money and credit. The board is composed of seven members of the board of governors and five presidents of Reserve Banks. Among the five presidents, one of them is the president of the Federal Reserve Bank of New York. The other members hold the voting position for one year terms on rotational basis. The Federal Reserve Banks are independently incorporated with nine boards of directors. The function of the Federal Reserve Banks is to set the rate of interest although subjected to approval by Board of Directors. They monitor the economy and provide financial services to the U.S. government and depository institutions. The member banks hold stock in their local Federal Reserve Bank. The advisory committees carry out various responsibilities within the system. Lesson 11 Answer 1 The change is the reserve ratio is one such tool and is probably the most powerful. The term reserve deposits are used to define the percentage of reserves the banks are required to keep against deposits. A decrease in the reserve ratio will provide the banks to lend more and the money supply in the economy will increase. The effect is just the opposite in reserve ratio is increased. The discount rate is another tool. It is defined as the rate of interest that central bank charges the commercial banks when need to borrow additional reserves. The interest rate is monitored by the Fed and does not depend on the market rate. Much of the rate is dependent on the signal Fed sends to the financial markets. The interest rates in the short term tend to depend on the movement of the market rate. The open market operations consist of buying as well as selling of securities of the government. The money supply within the economy increases when Fed buys back the securities from the banks and dealers. Answer 2 The increase in the prices of crude oil will confront the economy with having to raise the prices of the goods as well as services that they produce, the level of profits will be on the decline, the personal expenses and investments will face constraints. The revenue will fall coupled with rise in costs. The broad impact will fall upon the industries dependent on direct oil consumption. The diagram below shows a clearer picture. In an economy characterised by full employment, an increase in crude oil prices will lead to fall in equilibrium GDP while the equilibrium level of prices will be at a higher state than before. The Federal Government must use stringent monetary policy to combat inflation. Monetary policy acts in decisive fashion to short term inflation which is driven by demand stimulation. To tackle the rising levels of inflation it is necessary to reduce the level of aggregate demand. The Fed can achieve this through the three below mentioned ways. It can discourage the borrowing activities made by the households and the companies and increase the savings rate since the opportunity cost of expenditure is on the rise (Yanagisawa, 2012, p. 2). If Fed utilizes the above mentioned suggestions the equilibrium level of output and price will fall. If Fed uses the above mentioned policy, the equilibrium level of output will fall further while the price will fall as well. Answer 3 In situations characterised by high unemployment the monetary policy tools followed by Fed may not be effective enough. The price level in the economy in U.S. has not been stable and time calls for immediate intervention of the government. The Fed follows the traditional methods in monetary policies to tackle the rising issues in the economy which in some cases lack sharpness. It would be highly appreciated if the Fed comes up with new models of monetary policy that will be effective in taking care of the economy in times to come. Answer 4 The fiscal and monetary policy complement each other by trying to achieve the same goal of increasing the level of planned spending which has the potential to affect gross domestic product. The monetary policies are dependent upon the supply of money in the economy while the fiscal policy is dependent on the spending of the government. Increasing the supply of money in the economy is likely to be the appropriate policy in stimulating a recessionary economy by rising government spending and lowering taxes. The level of output will rise along with interest. This is also known as the crowding out in economics. References Yanagisawa, A. 2012. Impact of Rising oil prices in the macro economy. [pdf]. Available at: http://eneken.ieej.or.jp/data/4338.pdf. [Accessed: 24th January, 2013]. Read More