Suppose that the total holdings of banks in the U.S. were as follows: required reserves = $45 million excess reserves = $15 million deposits = $750 million loans = $600 million Treasury bonds = $90 million a) Draw a T-account and show that the balance sheet balances if these are the only assets and liabilities. b) What happens to each of these values if banks reduce their holdings of Treasury bonds by $77.5 million and the central bank changes the reserve requirement ratio to 5%? Illustrate your answer with a new T- account. c) Assume that people hold no currency. How much does the money supply change by if banks use their excess reserves to make loans? d) Draw a new T-account to illustrate your answer to part (c). e) What could be a reason(s) that the actual money supply change is different from your answer to part (c)? In your answer, please state if the money supply change could be lower or higher, why. f) Illustrate the impact of the money supply change that you calculated in part (c) using IS-LM and AD-AS diagrams. Make sure to label all axes and curves and write equations for each of the curves. Label the initial equilibrium (1) and new equilibrium (2). Describe how the new equilibrium is different from the old one. What is the intuition for your result? Note: if you are not sure about your answer to part (c), make an assumption about the change of the money supply, if any, write it down, and use it to answer part (). g) Next, assume that the Federal government considers to heavily cut spending on NASA projects, such as exploration of the Moon and Mars, in an attempt to reduce the U.S. budget deficit. Illustrate the potential impact of these actions on the economy using the diagrams you draw for part (f). Please label the new equilibrium (3), compare it to equilibrium (2) and explain the intuition for your results. h) As an alternative way to close the deficit, the U.S. Congress considers a tax hike. Assume that the amount of revenues that the new taxes are projected to collect is equal to the amount of budget savings described in part (g). Members of the Congress who introduced the tax bill, claim that the economic effects of their proposal are identical to the effects of the cuts to space exploration. Do you agree with their claim? Please explain your answer. Note: you do not have to illustrate your answer to part (h) on your diagrams. i) Does the monetary neutrality hold in the ADAS model? Why? j) Does the monetary neutrality hold in the ISLM model? Why? Suppose that the total holdings of banks in the U.S. were as follows: required reserves = $45 million excess reserves = $15 million deposits = $750 million loans = $600 million Treasury bonds = $90 million a) Draw a T-account and show that the balance sheet balances if these are the only assets and liabilities. b) What happens to each of these values if banks reduce their holdings of Treasury bonds by $77.5 million and the central bank changes the reserve requirement ratio to 5%? Illustrate your answer with a new T- account. c) Assume that people hold no currency. How much does the money supply change by if banks use their excess reserves to make loans? d) Draw a new T-account to illustrate your answer to part (c). e) What could be a reason(s) that the actual money supply change is different from your answer to part (c)? In your answer, please state if the money supply change could be lower or higher, why. f) Illustrate the impact of the money supply change that you calculated in part (c) using IS-LM and AD-AS diagrams. Make sure to label all axes and curves and write equations for each of the curves. Label the initial equilibrium (1) and new equilibrium (2). Describe how the new equilibrium is different from the old one. What is the intuition for your result? Note: if you are not sure about your answer to part (c), make an assumption about the change of the money supply, if any, write it down, and use it to answer part (). g) Next, assume that the Federal government considers to heavily cut spending on NASA projects, such as exploration of the Moon and Mars, in an attempt to reduce the U.S. budget deficit. Illustrate the potential impact of these actions on the economy using the diagrams you draw for part (f). Please label the new equilibrium (3), compare it to equilibrium (2) and explain the intuition for your results. h) As an alternative way to close the deficit, the U.S. Congress considers a tax hike. Assume that the amount of revenues that the new taxes are projected to collect is equal to the amount of budget savings described in part (g). Members of the Congress who introduced the tax bill, claim that the economic effects of their proposal are identical to the effects of the cuts to space exploration. Do you agree with their claim? Please explain your answer. Note: you do not have to illustrate your answer to part (h) on your diagrams. i) Does the monetary neutrality hold in the ADAS model? Why? j) Does the monetary neutrality hold in the ISLM model? Why
