Problem Set 7 (PS7)
 Principles of Macroeconomics (Eco 200-800) SUNY-Oswego Solutions will be posted or distributed by Wed., April 12, 2000 Ranjit Dighe

I.  LIFE AIN'T NOTHING BUT BANKING AND MONEY

A.  Case & Fair (5th edition), Chapter 11: #9
-- For question 9.c., give two answers:

• First, what is the initial amount by which the bank can increase its loans, based on its current level of excess reserves?
• Second, if all money loaned out is redeposited as cash into the same bank, then what is the ultimate amount by which the bank can increase its loans? (Hint: the money multiplier comes into play here.)
B. Case & Fair, Chapter 12: #3, 4, 5, 6

C. Case & Fair, Chapter 13: #1, 7

II. MO' MONEY

The Bailey Bank has the following assets and liabilities (in millions): Checking deposits (\$4500); Loans to Bedford Falls home buyers (\$4000); Reserves (\$500); Treasury bonds (\$500); Savings deposits (\$200); and Net worth. The required reserve ratio (RRR) is 10 % (or .10) on checking deposits and 0 % on savings deposits.

1.  Construct the Bailey Bank's balance sheet. What is M1 at Bailey? M2?

2.  Calculate Bailey's excess reserves (ER). Next assume that Bailey uses its excess reserves to make loans to Bedford Falls home buyers. Construct Bailey's new balance sheet after it no longer has any excess reserves but before any loans are redeposited at Bailey.

3.  Assume that all new loans in Bedford Falls are redeposited into checking accounts at Bailey and that Bailey loans out any excess reserves to Bedford Falls home buyers. Construct Bailey's ultimate balance sheet when it no longer has any excess reserves and when all additional Bedford Falls loans are back at the Bailey Bank. (Hint #1: After all is said and done, Bailey will have \$500 in reserves. Hint #2: The money multiplier comes into play here.)

4.  What are the new levels of M1 and M2, corresponding to the final balance sheet? What is the change in the money supply from the initial balance sheet to the final one? What is the money multiplier?