2HH3/Q#4: Circle A is the statement is true and circle if the statement is false

Econ 2HH3

Quiz #4March 31, 2014 Bubble A if the statement is true and bubble B if the statement is false.

1.When central bank buys bonds from other banks, it increases monetary base. This action (open market purchases of securities by central bank) described in the preceding sentence can be called monetary stimulus or quantitative easing policy.2.Money supply (M) equals monetary base plus cash with non-bank public.

3.When Bank of Canada buys securities from other banks, it leads to excess reserves with other banks, which leads to loan-creation and deposit-creation.

4.If M1 is $800 billion and the money multiplier is 2.5, then the monetary Base is $320 billion.5.Money multiplier = (1+cr)/(cr + rr), where cr is cash-deposit-ratio and rr is the reserve ratio.

6.If money multiplier is 3 and the reserve ratio is 0.2, we can conclude that the cash-deposit ratio must be less than 0.2.Answer Questions #7-11 on the basis of the following Taylors Rule:

i = in + + 0.5( *) + 0.5(Y YP), where YP is the potential GDP, * is the target inflation, is the actual inflation and i is the nominal interest rate set by the central bank. The interest rate at full-employment (or natural rate) GDP is in. When central bank conducts its policy response it assumes that * is 2 percent and in is 2 percent.

7.Taylors Rule will not apply if GDP gap is minus 10 percent. In this case, central bank conducts quantitative easing policy (i.e. monetary stimulus policy).8.Taylors Rule will not apply if inflation rate is minus 10 percent. In this case, central bank conducts quantitative easing policy (i.e. monetary stimulus policy).9.If GDP gap is minus 1 percent and at the same time, inflation rate falls to 1 percent, the central bank will keep the nominal rate at 2 percent.

10.If GDP gap is minus 1 percent and at the same time, inflation rate falls to 1 percent, the central bank will keep the real interest rate at 1 percent.

11.If GDP gap is plus 2 percent and at the same time, inflation rate increases to 4 percent, the central bank will keep the real interest rate at 4 percent. Higher real interest rate will dampen private spending.12.If the Bank of Canada buys US dollars from chartered banks in Canada, the Bank of Canada increases monetary base in Canada.13.M = [1 +cr]D, where D = demand deposits.

14.If the Bank of Canada decreases its bank rate and, at the same time, the Bank of Canada buys large sum of US dollars from the market, the Monetary Base in Canada must increase.

15.According to Baumol-Tobin model, only asset demand for money depends on the interest rate, while the transaction demand for money depends only on income.16. The income-elasticity of money-holding is 0.5 and the interest-elasticity of money-holding is - 0 5.

17.According to Baumol-Tobin model, as transaction costs (F) of money-withdrawal increases, the number of withdrawals (N) decreases.

18.According to Baumol-Tobin model, as interest rate increases, the transaction demand for money decreases.19.According to Baumol-Tobin model, as Y increases by 10%, the transaction demand for money increases by 10%.20.According to Baumol-Tobin model, as r increases by 10%, the transaction demand for money decreases by 10%.

21.If i = 0.01, Y = 1600 and F = 2, the optimal number of visits (N) to the bank (or optimal number of withdrawals from bank) is 2.

22.If i = 0.01, Y = 1600 and F = 2, then the total cost (TC) of holding money is 8.23.If cr is 0.2 and rr is 0.1 and if the Bank of Canada conducts an open market purchase of securities worth $10 million, then the maximum expansion of money supply in Canada will be $40 million. 24.If Bank of Canada re-deposits government deposits to Chartered Banks in Canada, it leads to more bank deposits, more bank reserves and larger monetary base. The effect is similar to the open market purchase of securities.25.Higher the interest-rate, higher is the present-value of perpetuities.Solution

True = a

False = b

1.True

2.False

3.True

4.TrueM = Money multiplier times (MB)

800 = 2.5(MB)

MB = 800/2.5 = 320

5.True

6.FalseMoney multiplier = (1 + cr)/(cr + rr)

3 = (1 + cr)/(cr + 0.2)

Find cr = 0.2

7.TrueNominal interest rate cannot be negative

8.True

9.Truei = 2 + 1 + 0.5(1 2) + 0.5(-1) = 2 percent

10.TrueReal interest rate = i = 2 1 = 1 percent

11.TrueReal interest rate = i = 8 4 = 4 percent

12.True13.True

14.True

15.False

16.True

17.True

18.True

19.False

20.False

21.True

22.True

23.True

24.True

25.False