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Exam 15: A: Interest Rates and Monetary Policy

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The total demand for money is equal to the transactions demand plus the asset demand for money.(a) Assume that each dollar held for transactions purposes is spent on the average five times per year to buy final goods and services.If nominal GDP is $800 billion, what is the transactions demand? (b) The table below shows the asset demand at certain rates of interest.Using your answer to part (a), complete the table to show the total demand for money at various rates of interest. (c) If the money supply is $240 billion, what will be the equilibrium rate of interest? (d) If the money supply rises, will the equilibrium rate of interest rise or fall? (e) If GDP rises, will the equilibrium rate of interest rise or fall?

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(a) Transactions demand for money is $16...

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Question 2

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What is meant by the Liquidity Trap? Provide an example.

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The Bank of Canada cannot be certain of ...

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When does the use of monetary policy create conflicts between the goals of macroeconomic stability and balance of international trade?

Describe the links between monetary policy and the international economy due to the net export effect, and its impact on the trade deficit.

What are the political and economic limitations upon (a) fiscal policy and (b) monetary policy?

How do the lags associated with monetary policy differ from those associated with fiscal policy?

Differentiate between expansionary and restrictive monetary policies.

Why is the transactions demand for money less than nominal GDP?

What is the net export effect of a tight monetary policy? Explain.

Use the table below to answer the questions: (a) If the transactions demand for money equals 10% of nominal GDP, nominal GDP is $800 billion, and the money supply is $480 billion, what is the equilibrium interest rate? (b) If nominal GDP remains constant, and the money supply is decreased from $480 to $380 billion, what will the equilibrium rate of interest be?

How does an increase in the price level affect the equilibrium rate of interest?

What is the goal of monetary policy?

What are the two reasons that people want to hold money? In other words, what are the two types of demand for money?

Suppose the economy is experiencing inflation.Describe the transmission mechanism through which monetary policy could address this problem?

Explain how nominal GDP and the real interest rate are related to the transactions and asset demands for money.

Use the table below to answer the questions. (a) If the transactions demand for money equals 10% of nominal GDP, nominal GDP is $600 billion, and the money supply is $360 billion, what is the equilibrium interest rate? (b) If nominal GDP remains constant, and the money supply is increased from $360 to $460 billion, what will the equilibrium rate of interest be?

The following are simplified balance sheets for the chartered banking system and the Bank of Canada.Perform the two following transactions, (1) and (2), making appropriate changes in columns (1) and (2) in each balance sheet.Do not cumulate your answers.Also, answer these three questions for each part: (a) What change, if any, took place in the money supply as a direct result of this transaction? (b) What change, if any, occurred in chartered bank reserves? (c) What change occurred in the money-creating potential of the chartered banking system if the reserve ratio is 20%? All figures are in billions of dollars.Consolidated Balance Sheet: Chartered Banking System Consolidated Balance Sheet: Bank of Canada (1) Suppose a drop in the bank rate causes chartered banks to borrow an additional $2 billion from the Bank of Canada.Show the new sheet figures in column 1.(2) The Bank of Canada buys $3 billion of government bonds from the public.Show the new balance sheet figures in column 2.

Following are the consolidated balance sheets of the chartered banks.Assume that the desired reserve ratio for banks is 10%.The figures in column 1 show the balance sheets' condition prior to each of the following five transactions.Place the new balance-sheet figures in the appropriate columns and complete A, B, C, D, and E for each column.Start each part (2-4) with the figures in column 1.All figures are in billions of dollars.

The following are simplified balance sheets for the chartered banking system and the Bank of Canada.Perform the two following transactions, (1) and (2), making appropriate changes in columns (1) and (2) in each balance sheet.Do not cumulate your answers.Also, answer these three questions for each part: (a) What change, if any, took place in the money supply as a direct result of this transaction? (b) What change, if any, occurred in chartered bank reserves? (c) What change occurred in the money-creating potential of the chartered banking system if the reserve ratio is 20%? All figures are in billions of dollars.Consolidated Balance Sheet: Chartered Banking System Consolidated Balance Sheet: Bank of Canada (1) Suppose a drop in the bank rate causes chartered banks to borrow an additional$3 billion from the Bank of Canada.Show the new sheet figures in column 1.(2) The Bank of Canada buys $2 billion of government bonds from the public.Show the new sheet figures in column 2.

What are the five functions of the Bank of Canada? Which one is most important?