Short-Answer and Algebraic Questions: (The numbers in square brackets give the breakdown of the points for various parts of each question. To receive full credit, please explain your answers. Total of 60 points.)

1. In the last quarter of 2019 (2019Q4) just before COVID-19 pandemic hit the United States, the economy's real GDP, Y, was $19.25 trillion (in constant 2012 U.S. dollars). At that time, GDP deflator, P, was 1.13, money supply, M^s, was $4 trillion, and the nominal interest rate, i, was 1.5 percent (i = 0.015). Assume that the money market is always in equilibrium. As you know from Module 4 materials, money demand is represented by M^d = kPY/i, where k is the propensity to hold money. (Please use the units given in the exercise setup in the formula: e.g., Y and M in trillions of dollars; i in decimals; P as given; etc.).

(a)What was the propensity to hold money in the U.S. in 2019Q4 (i.e., what was k)? Please round the answer to 5 decimal points and show your calculations. [5]

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(b)During the COVID-19 pandemic in 2020, the Fed increased the money supply dramatically. In 2021Q1, the money supply had reached $18.4 trillion, while real GDP was $19.1 trillion, GDP deflator was 1.15, and the interest rate was 0.08 percent, i = 0.0008. What was k in the U.S. in 2021Q1? How does the magnitude of this value compare with the value of k you found for 2019Q4 in part (a)? Please round the answer to 5 decimal points and show your calculations. [5]

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(c)In the situation described in part (b) above, we want to know the extent to which the change in the propensity to hold money, k, helped or hindered the Fed's effort to lower the interest rate. To explore this issue, suppose in 2021Q1 when the money supply reached $18.4 trillion, k had remained the same as it was in 2019Q4, which you found in part (a). What would have been the equilibrium interest rate in 2021Q1 in that case? How does this interest rate compare to 0.08 percent that actually prevailed in 2021Q1? Did the actual change in the propensity to hold money help or hinder the Fed's goal of lowering the interest rate? Please express your answer as a percentage, round to 3 digits after the decimal point, and show your calculations. [7]

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(d)Currently, the U.S. money supply is $19 trillion. In summer of this year, 2021Q3, real GDP is expected to reach $19.8 trillion and GDP deflator to be 1.17. If the propensity to hold money k remains at the level you found in part (b) above and the Fed wants to set the interest rate at 0.1 percent (i = 0.001), how much money should it inject or withdraw from the money market? Please express your answer in trillions of dollars, round it to one digit after the decimal point, and show your calculations. [8]

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(e)In part (d) above, suppose in 2021Q3 the propensity to hold money reaches k = 0.00095 rather than staying at its 2021Q1 level. Given the current money supply and expected GDP and deflator mentioned in (d), if the Fed wants to keep the interest rate at 0.1 percent (i = 0.001), how much money should it inject or withdraw from the money market? Please express your answer in trillions of dollars, round it to one digit after the decimal point, and show your calculations. [5]

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A RECESSION strikes. Central banks leap into action, cutting interest rates to perk up investment. But what if, as now, there is not much cutting to do, with rates already at or close to zero? In such cases the manual calls for purchases of government bonds with newly printed cashquantitative easing, or QEswelling the reserves each bank keeps at the central bank. Imagine instead that people also kept accounts at the central bank. New money could be added to their accounts, providing a direct, equitable boost to spending. That is one of several potential benefits of individual central-bank accounts, which are among the more intriguing of the radical policy ideas in circulation.

Central banks deal in two sorts of currency: cash, which anyone can hold, and digital money, accessible only to financial institutions through their accounts at the central bank. Individuals hoping to spend digital money must use a bank card or transfer (or a service, like Apple Pay, linked to a bank account), or a private crypto-currency such as bitcoin or Ethereum. Some central banks are considering whether and how to expand the use of their own digital money. Sweden's Riksbank, for example, is exploring ways to widely used e-krona. In June Swiss voters will participate in a referendum on a radical monetary reform, one effect of which would be to give individuals access to digital money at the Swiss National Bank (SNB). The main difficulty central banks face is how to facilitate the circulation of digital currency without routing everything through banks, as happens today.

Blockchain technology, which underpins crypto-currencies, could be one way to avoid the banks. In such systems balances and transactions are tracked on a distributed public ledger, secured with cryptography. But central banks worry about security risks and technical challenges. And as Aleksander Berentsen and Fabian Schar write in the latest quarterlyReviewof the Federal Reserve Bank of St Louis, central-bank backing for anonymised transactions would be awkward when private banks face demands to crack down on money-laundering and tax evasion. Easier and less risky would be to extend the privilege enjoyed by banks, to hold digital money at the central bank, to everyone.

Why, though, would central banks want to do so? One answer is that individual accounts could help them with their monetary-policy mission. At present, they manage interest rates across the economy indirectly, by adjusting the rates banks earn on their reserves. But these are passed on only imperfectly to consumers. At the moment, banks in America can earn a short-run, risk-free interest rate of about 1.75% (those in Europe and Japan earn less). Current accounts at private banks, meanwhile, pay approximately nothing. In a world of individual central-bank accounts, in contrast, the rate paid on individual deposits would become a potent policy tool. Rate changes would have a direct, transparent effect on depositors. And were central-bank digital money to account for a big share of transactions, swings in such spending could become a useful real-time source of data for policymakers.

The accounts would come in especially handy when near-zero interest rates leave central banks with few good options in a crunch. The effects of QE diminish over time, particularly when crisis-induced breakdowns in credit markets begin to heal. Central bankers could be more confident in the stimulative effect of what Milton Friedman termed "helicopter money": distributions to the public of newly minted dosh. These would bring complications. Money is commonly considered a liability of a central bank. Accountants would frown at distributing new money without obtaining assets in exchange (like the government bonds purchased when banks carry out QE), since they would create a huge negative position on central-bank balance-sheets. But an institution that can create its own money cannot go bankrupt. As long as a central bank is keeping to a policy target (like a 2% inflation rate) an ugly balance-sheet is not a problem.

Crucially, monetary policy oriented around individuals should be easier to understand than the customary prestidigitation. Political constraints on the use of QEthe perception that it is a giveaway to banks, or (in Europe) a way to prop up fiscally incontinent governmentsmight bind less tightly for injections of money into individual accounts.

A "public option" for banking ought to improve private banks' behaviour, too. To keep their deposits, they would need to offer useful services and competitive rates, rather than hidden fees. Guaranteed access to a simple, interest-paying savings vehicle, and to electronic money, could be a boon for the world's underbanked poor. And though it need not, such accounts could represent a first step away from deposit-financing of bank lending: a reform favoured by some economists and regulators.

QE too

No bold reform comes without difficulty. Administrative costs should be low, given the no-frills nature of the accounts. But the system would require investment in physical and digital infrastructure. Many people will be uncomfortable with accounts that give governments detailed information about transactions, particularly if they hasten the decline of good old anonymous cash. Poorly implemented systems could cause big trouble. The Swiss reform would move all demand deposits from private banks to the SNB and tie its hands in costly ways (although the proposal is unlikely to pass, polls suggest a surprising third of the population are in favour). Where central banks are less politically independent, courting votes by pumping accounts full of money, or punishing political opponents by draining them, could be irresistible.

But used well, individual accounts could improve consumer welfare as well as macroeconomic policy. It is a prospect that should raise interest.

2. This questions is based on the article, "Central banks should consider offering accounts to everyone," published by The Economist on May 26, 2018. The article examines the idea that people are allowed to open accounts at the central bank so that quantitative easing (QE)i.e. injecting large amounts of newly printed cash into the economycould be conducted directly through those accounts rather than indirectly via banks, as is the current practice. The article also argues that using electronic money for such accounts may enable the central bank to connect with the population and manage its monetary policies more directly, rather than going through the banking system, as is currently the case.

(a)According to the article, one consequence of individual central-bank accounts is that the central bank could gain more direct control of money supply. How does the banking system work right now, and who are the intermediaries between the central bank and the population? How may these intermediaries interfere with the monetary policies propagated by the central bank? And how would the proposed individual central-bank accounts impact monetary policy? [6]

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(b)According to the article, a second consequence of individual central-bank accounts is that it enables the central bank to implement QE policies more effectively. Why is this the case and what are its potential benefits? What's the connection of the individual central-bank accounts idea to 'helicopter money' and the unique advantage of the central bank over commercial banks in its administration? [8]

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(c)According to the article, individual central-bank accounts can change some of the political constraints on monetary policy, especially from the perspective of equity. Why is this the case and what are its potential benefits? [5]

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(d)According to the article, individual central-bank accounts may also create more competition for deposit-taking banks. Why is this the case and what are its potential benefits? [5]

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(e)According to the article, what are the potential pitfalls of individual central-bank accounts? [6]

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QUESTION 1

1.

Money is

a.

any item that can serve as store of value.

b.

any item that can serve as unit of account.

c.

any item that can be exchanged for goods and services.

d.

any item that can be exchanged for goods and services and at the same time can serve as store of value and unit of account.

QUESTION 2.

The interest rate is

a.

the price of using money.

b.

the return on holding gold.

c.

the return on holding the stocks of private companies.

d.

the extent of enthusiasm about learning about the economy.

QUESTION 3.

In today's economies, the supply of money in an economy is

a.

fixed by law.

b.

determined by the amount of gold held by the central bank.

c.

determined by the amount of all precious metals held by the central bank.

d.

determined by the amount of foreign assets held by the government.

e.

determined by the central bank's policies.

QUESTION 4.

Which one of the following events causes anincreasein the demand for money in an economy?

a.

A decline in the propensity to hold money, given the interest rate, the price level, and the real GDP.

b.

An increase in the interest rate, given the price level, the real GDP, and propensity to hold money.

c.

An increase in the price level, given the real GDP, the propensity to hold money, and the interest rate.

d.

A reduction in the value of market transactions, given the propensity to hold money and the interest rate.

e.

A rise in the average value of non-market economic activities carried out by households with no effect on market activities.

QUESTION 5.

As the European economy recovers from the COVID-19 pandemic this year, both the aggregate real income and the price level in the country are rising. If the interest rate and the propensity to hold money remain unchanged, the demand for money in Europe

a.

will rise.

b.

will decline.

c.

will remain unchanged.

d.

may rise or decline depending on the rate of interest prevailing in the economy.

e.

will decline if the rise in the price level is less than the increase in the aggregate real income.

QUESTION 6.

In 2019 in Vietnam, money supply,M^s, was 2,500 trillion Vietnamese dong, the one-year nominal interest rate,i, was 6 percent (i= 0.06), and money market was in equilibrium,M^s= kPY/i. If at the time, the propensity to hold money wask= 0.025, what was the nominal GDP,PY, of the Vietnamese economy in 2019?

a.

150 trillion Vietnamese dong

b.

1,042 trillion Vietnamese dong

c.

2,500 trillion Vietnamese dong

d.

6,000 trillion Vietnamese dong

e.

41,667 trillion Vietnamese dong

QUESTION 7.

In question 6 above, suppose in 2020 Vietnam's nominal GDP and the propensity to hold money remained the same as they were in 2019. If the central bank wanted to lower the interest rate to 4 percent in 2020, how much money should it supply to the market?

a.

1,667 trillion Vietnamese dong

b.

1,750 trillion Vietnamese dong

c.

2,500 trillion Vietnamese dong

d.

3,750 trillion Vietnamese dong

e.

4,000 trillion Vietnamese dong

QUESTION 8.

The LM curve shows how

a.

the exchange rate is determined by real income in the money market.

b.

real income is determined by the rate of interest in the money market.

c.

the rate of interest in the money market is determined by real income.

d.

the supply of money in the money market is determined by real income.

e.

the supply of money in the money market is determined by the rate of interest.

QUESTION 9.

The Reserve Bank of India (RBI) had kept its benchmark interest rate at around 6-8% between early 2011 and early 2020. When the COVID-19 pandemic hit India in 2020, RBI decided to expand money supply and to lower interest rates to help struggling firms and households. This meant that in 2020 the LM curve of Indian economy

a.

must have become flatter.

b.

must have become steeper.

c.

must have remained unchanged.

d.

may have become flatter or steeper depending on the extent of money supply increase.

QUESTION 10.

The economy of United Kingdom is expected to experience a decrease in aggregate real income in 2021, but no change in the price level or money supply. As a result of this decrease in aggregate real income, the LM curve of the U.K. economy

a.

will become flatter.

b.

will become steeper.

c.

will not be affected.

d.

may become flatter or steeper.