Economics and Statistics

  Tools of central bank policy: The RRR: it changes the amount of excess reserves in commercial banks, and changes the size of the money multiplier and thus impact how much money the banking system can create. In an expansionary policy, the Fed wants to lower the RRR in order to increase the amount of excess reserves. Commercial banks are then incentivized to loan it out. This will increase the supply of money in the economy which will then lower the nominal interest rate (i.e banks agree to loan out more at lower rates than before). In a contractionary policy, the Fed wants to increase the RRR, which will reduce the supply of money in the economy. The number of loans diminishes and the nominal interest rate goes up. Assume the RRR goes from 20% to 25%: we see that the money multiplier (m) goes from 5 to 4. Commercial banks create less money than before and make less loans. In the money market, the money supply curve shifts to the left, which causes the real interest rate to increase (

  Assume that you have the following information about the Dm and Sm curves: If the RRR is 15%, find the maximum effect on the money supply when the Fed buys a quarter of a million dollars worth of bonds from commercial banks. What is the new nominal interest rate at equilibrium? Calculate the original equilibrium nominal interest rate: Calculate the maximum effect from the Fed's action: Find the new Sm curve (assuming max effect): Find the new nominal interest rate at equilibrium: Let's graph that: Now assume that the expected inflation is supposed to be 0.2%, find the effect of the central bank on the loanable funds market (just show the effect on the demand curve). What is the old and new real interest rate at equilibrium. Let's graph that: Finally describes the impact of the Fed's action on the AD/AS model in the short run. The variable I (for investment) goes up which implies that the aggregate demand curve shifts to the right. Putting upward pressure on the price

  The money market: The money market combines the supply of money and the demand for money for a country. The supply curve (Sm) is inelastic and is determined by the central bank. The demand curve (Dm) is the horizontal summation of the asset and transaction demand curves and is sloping downward. The intersection between the Sm and Dm is the equilibrium interest rate for a country. A change in the nominal interest rate implies that either or both curves (i.e Sm and Dm) have shifted to the right or left. An increase in nominal GDP (P*Y) will lead to an increase in the transaction demand for money which will shift the total demand (Dm) to the right. The nominal interest rate goes up. A decrease in the level of output (Y) will shift the Dm curve to the left. The Sm curve will shift whenever the central bank decides to change the money supply due to a monetary policy decision. The Fed expands the supply of excess reserves in commercial banks, by purchasing bonds from banks, Sm shifts to th

Different "types" of money: M1: the money held in coins and bank notes, and in checking account deposits. This is the most liquid form of money. M2: M1 plus savings accounts and small time deposits that cannot be used within a certain period of time. Note that M2 is bigger than M1 but slightly less liquid. M3: M1 and M2 plus larger time deposits. This is bigger and less liquid than M2. Money supply: It measures the amount of money available to households and firms at some point in time (usually represented by either the M1, M2, or M3). The money supply is mainly determined by the central bank (also known as the Federal Reserve, or the Fed, in the US). The central bank influences the interest rate through monetary policies aimed at changing the money supply. Note that the money supply curve is perfectly inelastic, since the Fed makes decisions that are not influenced by the nominal interest rate. The y-axis is the nominal interest rate, which can be think of it as the price of