Economics

David Begg, Gianluigi Vernasca, Stanley Fische

Chapter 19

Interest rates and monetary transmission - all with Video Answers

Educators

Chapter Questions

Problem 1

The Bank of England sells $£ 1$ million of securities to Mr Jones who banks with Barclays. The Bank of England requires other commercial banks to hold 100 per cent cash reserves against deposits. What is the money multiplier?

Jennifer Stoner

Jennifer Stoner

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Problem 2

Which of these statements is correct? The purpose of quantitative easing is: (a) to create money in order to create inflation and reduce the real value of government debt; (b) to force banks to create deposits despite having inadequate bank reserves; (c) to make the central bank the purchaser of last resort for government bond issues; (d) to prevent a collapse of broad money when banks are unable or unwilling to lend.

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 3

What are the desirable properties of a good leading indicator for interest rate decisions?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 4

What happens to the consumption function if the banks decide to offer credit cards on easier terms and conditions? Why?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 5

Common fallaciesWhy are these statements wrong? (a) By abolishing reserve requirements, the central bank gave up any attempt to control the money supply. (b) When real interest rates are negative, people are being paid to hold cash. (c) Consumers are said to behave irrationally if their spending is up when their disposable income is lower.

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 6

The Bank of England sells $£ 1$ million of securities to Mr Jones who banks with Barclays. (a) If Mr Jones pays by cheque, show the effect on the balance sheets of the Bank of England and Barclays. (b) What happens to the money supply? (c) Is the answer the same if Mr Jones pays in cash?

Kaylee Mcclellan

Kaylee Mcclellan

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Problem 7

Using a diagram like Figure 19.1: (a) illustrate the initial effects of a recovery in confidence after a financial crash. (b) Did you expect a larger effect on money supply or money demand? (c) How will monetary policy then respond?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 8

Suppose banks begin lending again as confidence is restored. (a) If monetary policy takes no action, what will be the likely outcome? (b) What action by the central bank would then be appropriate?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 9

Why might it take up to two years for a change in interest rates fully to affect aggregate demand? What does this imply about decisions to set interest rates?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 10

If the permanent income hypothesis is correct, we should expect to see a lower marginal propensity to consume in the short run than in the long run. Why?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 11

Why do higher interest rates reduce investment demand? Be sure to discuss all the different ways in which firms might finance their investment projects.

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 12

Consider a simplified version of the model in Maths 19.2, in which money demand, the deposit multiplier and aggregate demand are, respectively: $M=Y-r$ $M=m R Y=100-r$
a. If output is 90 , find the interest rate and the level of bank reserves and the level of bank reserves.
b. suppose, autonomous aggregate demand falls from 100 to 95 , and the deposit multiplier falls from $m$ to $m / 2$. How much must reserves increase to preserve the initial level of output? (c) What is the maximum fall in autonomous aggregate demand that can be offset by quantitative easing?

Manasvee Singh

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Problem 13

Essay question Why do modern central banks think of monetary policy as choosing the interest rate rather than the money supply?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 14

You live for five periods, during which, respectively, you earn $100,200,300,200$ and 100 . (a) Draw a diagram of your lifecycle income. (b) If the interest rate is zero, and there is no inflation, what is your permanent income? (c) Using your diagram, or otherwise, identify your saving or dissaving in each period of your life. (d) If the real interest rate is positive instead of zero, what effect does this have on your initial estimate of your permanent income? Illustrate in your diagram.

Ryan Mcalister

Numerade Educator