04.03DEFINITION, MEASUREMENT, AND FUNCTIONS OF MONEY

For each of the questions below, answer directly and succinctly.

(a) A bank is offering 5-year certificates of deposit (CDs) with a 3% interest rate. The expected inflation rate is 1%. Calculate the expected real interest rate on the CD. (Show your work.)

(b) Banks across the country are decreasing nominal interest rates. What will happen to the price of government bonds?

(c) Explain the relationship between the aggregate measures of the money supply and liquidity.

(d) Why would it be impossible for M0 to be greater than M1? Explain.

For each of the following tasks, calculate the values of M0, M1, and M2 after the indicated change. Show your work where applicable, and clearly identify your answers for each.

(e) Initial values: M0 = $100,000, M1 = $240,000, and M2 = $400,000. A person transfers $100,000 from a checking to a savings account.

• M0 =
• M1 =
• M2 =

(f) Initial values: M0 = $60,000, M1 = $130,000, and M2 = $350,000. Someone purchases a $35,000 car with cash. The car dealership deposits the cash into its business checking account.

• M0 =
• M1 =
• M2 =

(g) Initial values: M0 = $210,000, M1 = $400,000, and M2 = $900,000.A business withdraws $10,000 from its checking account for miscellaneous expenses.

• M0 =
• M1 =
• M2 =