BUS 535: Economic Issues Discussion Questions Set 2, Summer 2019

This document presents solutions to a set of discussion questions from BUS 535, focusing on economic issues. The questions delve into the impact of credit cards on the monetary system, exploring their effects on money demand, supply, velocity, spending, and inflation. It also examines the implications of bank failures on the monetary system and the broader macro-economy, including government policies like regulations and bailouts, with ethical considerations. Furthermore, the assignment analyzes the money supply under different reserve scenarios, investigates the effects of a check tax, and explores the concept of leverage ratios in banking. Additional topics covered include hyperinflation, the influence of inflation on consumption and investment, the importance of indexing Social Security benefits, and the economic effects of deflation and the gold standard. This comprehensive analysis offers insights into various economic concepts and their real-world implications.

BUS 535—Economic Issues, summer 2019
Discussion Questions Set 2
Question 1:
Credit cards affect the monetary system by reducing the demand for money in the short-
run, and in the long-run, the repayment of credit bank debt, increases the demand for
transactional money. However, it is widely believed that the increased use of credit cards will
reduce the money supply.
Question 2:
Banks play an important role in the transmission of the government’s monetary policy
aimed at achieving economic growth without inflation. Bank failures have great ramifications to
their customers, the community, other banks, and the nation as whole. When a bank fails,
customers cannot access their deposits or other services such as loan which creates money. To
avoid the great disruptions, nations tend to insure deposits in case of a bank failure, in addition to
highly regulating the banking sector.
Question 3:
a. When all money is held as currency, the money supply equals to the monetary base.
Monetary base = 1,000 * $1 = $1,000. Therefore, the money supply is $1,000.
b. When all the money is held as demand deposit, and the bank holds 100 percent of the
deposits as reserves, there are no loans disbursed. Therefore, the money supply = $1 *
1,000 = $1,000.
c. When all the money is held as demand deposit, and the bank holds 20% of the deposits as
reserves, then the reserve-deposit ratio is 20/100 = 0.20. The currency deposit ratio is
zero.
The money multiplier is: m = (cr+1)/ (cr+rr) = (0+1)/(0+0.20) = 1/0.20 = 5
Therefore, the money supply is equal to the monetary base times the money multiplier,
that is $1,000*5 = $5,000.
d. When people hole equal amounts of currency and demand depots, and banks hold 20% of
deposits as reserves, then the reserve-deposit ratio is 0.2, and the currency-deposit ratio is
1.
The money multiplier is: m = (cr+1)/ (cr+rr) = (1+1)/(1+0.20) = 2/1.20 = 1.667
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Therefore, the money supply is equal to the monetary base times the money multiplier,
that is $1,000*1.667 = $1,666.67.
e. The monetary base is proportional to the money supply, where the money supply, M =
Money multiplier, m X Monetary Base, B. If the m is a constant number, then a 10%
increase of the money supply by the central banks, should increase the monetary base by
10 percent. This is subject to the currency-deposit ratio and reserve-deposit ratio
remaining constant.
Question 4:
a. The check tax increased the currency-deposit ratio, cr. This is because people would be
reluctant to uses checking accounts as a means of exchange which will lead to a decrease
in deposits. The introduction of check tax would make checking accounts more expensive
for the citizens, hence people would prefer to use cash as a means of exchange. When
people hold more cash for transactional purposes, the currency-deposit ratio rises.
b. Under the fractional-reserve banking, the money supply, M1 = m*B, where the money
multiplier, m= cr +1
r +rr . With the checks being taxed, people decreased their use of
checking acconts and held more cash for transactions, then the cr =C /D increases;
therefore, the money multiplier decreases, which in turn decreases the money supply.
c. No, the check tax was not a good policy to implement in the middle of the Great
Depression. One, the check tax policy resulted to a decrease in the money supply, which
meant banks had less reserves to generate money from loans.
Question 5:
The balance sheet below is an example of a bank with a leverage ratio of 10; because the
total assets are $12,000 and capital is $1,200
Assets Liabilities and Owner’s Equity
Reserves $2,000 Deposits $8,000
Loans $6,000 Debt $2,800
Securitie
s
$4,000 Owner’s Equity $1,200
Total $12,000 Total $12,000
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If the value of the bank’s assets rises by 5%, the value of the owner’s equity will also rise
by 5 percent of the asset value, given that the deposits and debt values do not change. The total
value of both sides of the balance sheet must be similar.
For the bank’s capital to reduce to zero it would take the assets to decline in value by
$1,200, which is 10 percent of the current asset value.
Question 6:
Printing of money and seigniorage compare to fiscal policy because they are regarded as
a source of government revenue for economies experiencing hyperinflation.
Question 7:
The U.S is at a risk of experiencing hyperinflation given the recent figures on the Federal
monetary expansion which have been greatly rising. However, most of this amounts are in
Federal Reserve and not in circulation
Question 8:
In reality, inflation does effect Consumption and Investments. With the rise in prices,
consumers don’t spend much money buying commodities because their purchasing power is
eroded by inflation. With declining purchasing power, consumers are encouraged to spend and
businesses make capital investments. The reasoning is that many have the view that cash will
only lose value in future due to the inflation, so it’s best to use it sooner than later.
Question 9:
a. It is important the real value of Social Security and other benefits remain constant over
time. Hence, the legislator ensure that this is achieved by indexing benefits to the cost of
living which is measured by the consumer price index (CPI). The indexing ensures that
the nominal benefits change at the same rate as the prices. The decreasing rate of inflation
does not affect the amount received but the senior citizens. If measured correctly, the low
rate of inflations means that he price of goods and services purchased by the senior
citizens are cheaper. The decrease in their Social Security may mean that they get less
money from the government, but their purchasing power remains constant.
b. The article is not correct because the only way to cut real wages is to allow inflation to
run its course, when it’s not possible to cut the nominal benefits. If there was no inflation,
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then the wages would be stuck above the equilibrium level, which would results to
greater unemployment levels.
Question 10:
During deflation, consumers experience a decrease in the price level of most
commodities. Hence, there value of money is seen to increase. Consequently, during deflation,
the value of gold will rise as the value of money increases, since under a gold standard, money
and gold are in a fixed ratio. Therefore, after a period of deflation, it is expected that one ounce
of gold is able to buy more commodities, which creates an increase incentive to find new gold
deposits.
If a country returns to the gold standard, its money supply will be proportional to the
amount of gold the nation has. This would mean that the government would no longer be able to
control the money supply by raising interest rates in times of inflation or by decreasing interest
rate in times of recession. In other words, the gold stand would enforce fiscal discipline.
However, it will also limit the economic growth of a nation because it will no longer rely on the
resourcefulness of its people and businesses. There would be lack of capital to fund businesses.
Due to globalization, it would require that all nations return to the gold standard, for it to
effectively work in any particular nation.
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