Macroeconomics Homework 7: Analysis of Economic Policies

This document presents a complete solution to Macroeconomics Homework 7, addressing key macroeconomic concepts. The assignment includes calculations and analysis of the money multiplier, monetary base, money supply, and various ratios related to reserves and deposits. It further explores the concept of a liquidity trap, discussing the Federal Reserve's policies from 2009 to 2012 to combat it. The solution also examines the currency deposit ratio and reserve deposit ratio during the Great Depression and Great Recession, comparing the actions of the Federal Reserve in both periods. The assignment also involves calculations related to international trade, including equilibrium interest rates, desired savings, investment, and net exports for the USA and China. Finally, the solution considers the impact of inflationary expectations on real interest rates and analyzes the effects of monetary policy changes using real money supply and demand diagrams.

Running head: MACROECONOMICS HOMEWORK 7
Macroeconomics Homework 7
Name of the Student
Name of the University
Student ID

1MACROECONOMICS HOMEWORK 7
Table of Contents
Answer 1..........................................................................................................................................2
Answer 2..........................................................................................................................................2
Answer 3..........................................................................................................................................5
Reference.........................................................................................................................................8

2MACROECONOMICS HOMEWORK 7
Answer 1
The more realistic money multiplier is given by
Money multiplier (mm)=
1+ C
D
res+ C
D + R
D
Answer 2
(a) Monetary Base (BASE) is given by
Monetary Base=C+ R
¿ , BASE =1250+125
¿ , BASE =1375
¿ , BASE =$ 1375 b
(b) Money Supply (M) is given by
Money Supply
Monetary Base = C+ D
C+ R
¿ , M
Base = 1250+1500
1250+125
¿ , M
1375 = 2750
1375
¿ , M=$ 2750 b
(C) Ratio of reserves to deposits (res) is given by

3MACROECONOMICS HOMEWORK 7
Money Supply
Monetary Base =
C
D + D
D
C
D + R
D
In the above equation, R/D or ‘res’ is the reserve to deposit ratio and thus it can be shown as
R
D = 125
1500
¿ , res=0.0833
(d) Ratio of currency to deposit (cu) is given by
C
D =1250
1500
¿ , cu=0.8333
(e) Money Multiplier (mm) is given by
Money multiplier (mm)=
1+ C
D
C
D + R
D
¿ , Money multiplier (mm)= 1+0.8333
0.8333+0.08333
¿ , Money multiplier (mm)= 1+0.8333
0.8333+0.08333
¿ , mm=2.0001
(a) Money Multiplier (mm):

4MACROECONOMICS HOMEWORK 7
Money multiplier (mm)=
1+ C
D
C
D + R
D
¿ , Money multiplier (mm)= 1+ cu
cu+res
¿ , Money multiplier (mm)= 1+0.8333
0.8333+0.0694
¿ , Money multiplier (mm)=2.0309
(f) Money Supply (M):
Money Supply
Monetary Base =
C
D + D
D
C
D + R
D
¿ , Money Supply
1375 = cu+1
cu+res
¿ , Money Supply
1375 = 0.8333+1
0.8333+0.0694
¿ , Money Supply
1375 = 1.8333
0.9027
¿ , Money Supply =$ 2792.6250b
(g) Bank Deposits (D):
Monetary Base=C+ R
¿ , Monetary Base=(cu× D)+(res × D)
¿ , Monetary Base=(0.8333 × D)+(0.0694 × D)

5MACROECONOMICS HOMEWORK 7
¿ , 1375=(0.8333 × D)+(0.0694 × D)
¿ , 1375=D ×(0.8333+0.0694)
¿ , 1375=D × 0.9027
¿ , 1375=D ×(0.8333+0.0694)
¿ , D=$ 1523.2081 b
(h) Currency held by the public (C):
C
D =cu
¿ , C
1523.2081 =0.8333
¿ , C=$ 1269.2893b
(i) Bank Reserves (R):
¿ , R
D =res
¿ , R
1523.2081 =0.0694
¿ , R=$ 105.7106 b
Answer 3
Liquidity trap happens when people of a country holds all the money that is circulated by
the central bank on the economy (Guerrieri and Lorenzoni 2017). Under this condition, any
increase in money supply by the central bank would be held by the people. There would be no

6MACROECONOMICS HOMEWORK 7
increase in aggregate demand of the economy since people would not spend the extra money
they received (Carvalho and Rezai 2016). In addition to that interest rate would not change as the
central bank has already reduced the interest rate to lowest possible level to increase the money
supply in the economy and thereby boost the spending. As a result, the economy stays in
liquidity trap. From 2009 to 2012, the fed undertook three unusual policies to bring the US
economy out of the problem of liquidity trap are changing the assets’ composition that the
central bank held with it, impacting the expectations of interest rate and the size of the balance
sheet of central bank is expanded.
(a) The sum of currency held by the people of a country which is actually a part of aggregate
deposits held by the banks of the country give the currency deposit ratio. The Currency Deposit
Ratio is also symbolized as cu. Dividing the currency held by the people of a country by the
aggregate deposit gives the currency deposit ratio (Zinn 2017). From the given diagram, it can be
seen that Currency Deposit Ratio is lower in the phase of Great Recession than in the case of
Great Depression. It happened because during Great people had more trust on banks deposits.
The main reason of this is that Federal Deposit Insurance Corporation took the policy of insuring
all the deposits (Koch, Richardson and Van Horn 2016). It means that even if the commercial
banks lose money or have gone bankrupt the deposits by the people would be safe. Therefore,
people of the US did not withdraw their money out of the banks as they did during the period of
Great Depression.
(b) Total reserves (R) is the amount of money held to the central bank by the commercial banks.
However, the rule of keeping reserve is based on the reserve deposit ratio which is set by the
central bank. During the Great Depression, the reserve deposit ratio was decreased by the central
bank in order to increase the lending capacity of the commercial banks such that investment in

7MACROECONOMICS HOMEWORK 7
the industrial sector increases and the economy of the country faces boost (Ismal and Hidayat
2016). On the other hand, during Great Recession there was failure threat to the industry due to
difficult economic situation that was working against the business. In this scenario, more
investment in a failing sector would hurt the economy adversely. Due to this reason, the central
bank of the US that is the Fed increase the reserve deposit ratio. This is why the reserve deposit
ratio was higher in the period of Great Recession that in Great Depression.
(c) The action of Federal Reserve was different in case of Great Recession than in the case of
Great Depression. The reason for different action in both the cases is the level of economic
impact occurred due to each one of the economic downturns (Duca 2017). The Great Depression
was much more intense than the Great recession. Referring to the given diagram it can be said
that the Federal Reserve had acted differently because during the Great Recession the currency
deposit ratio and the reserve deposit ratio both were kept at high by the Federal Reserve whereas
during the period of the Great Depression the two ratios was at low. The reserves deposit was
low to boost economy and the currency deposit ratio was low as the economy was in liquidity
trap as the people were keeping their money to themselves.

8MACROECONOMICS HOMEWORK 7
Reference
Carvalho, L. and Rezai, A., 2016. Personal income inequality and aggregate demand. Cambridge
Journal of Economics, 40(2), pp.491-505.
Duca, J.V., 2017. The Great Depression versus the Great Recession in the US: How fiscal,
monetary, and financial polices compare. Journal of Economic Dynamics and Control, 81, pp.50-
64.
Guerrieri, V. and Lorenzoni, G., 2017. Credit crises, precautionary savings, and the liquidity
trap. The Quarterly Journal of Economics, 132(3), pp.1427-1467.
Ismal, R. and Hidayat, S.E., 2016. A proposed formula for reserve requirement–financing to
deposit ratio: The case of Islamic banking in Indonesia. In Macroprudential regulation and policy
for the Islamic financial Industry (pp. 121-131). Springer, Cham.
Koch, C., Richardson, G. and Van Horn, P., 2016. Bank leverage and regulatory regimes:
Evidence from the great depression and great recession. American Economic Review, 106(5),
pp.538-42.
Zinn, J., 2017. Our Textbooks are Wrong: How An Increase in the Currency-Deposit Ratio Can
Increase the Money Multiplier. Available at SSRN 3061224.