Question 1

Suppose the Federal Reserve decided to purchase $40 billion worth of government securities in the open market.

a. By how much will M1 change initially if the entire $40 billion is deposited into transactions accounts?

M1 will initially( increase/decrease) by:_________ billion

b. How will the lending capacity of the banking system be affected if the reserve requirement is 10 percent?

Total lending capacity will (increase/decrease) by:____________ billion

c. How will banks induce investors to utilize this expanded lending capacity?

As the money supply increases, interest rates will (increase/decrease)and investors will want to borrow____________ funds.

Question 2

Total reserves: 180 billion

Transactions deposits: 800 billion

Cash held by public: 300 billion

Require reserve ratio: 0.20

a. How large is the money supply (M1)?______ billion

b. Are the banks fully utilizing their lending capacity?

No, because banks currently have_________ billion in excess reserves.

Now assume that the public deposited another $20 billion in cash in transactions accounts.

c. What would happen to the money supply initially (before any lending takes place)?

Assuming the $20 billion in cash is not new money in the system, M1 will(not change)

d. How much would the total lending capacity of the banking system be after this portfolio switch?_________ billion

e. How large would the money supply be if the banks fully utilized their lending capacity?_________ billion