# 2. suppose in fantasia, a bank initially has \$10,000 of deposits; out

2. Suppose in Fantasia, a bank initially has \$10,000 of deposits; out of this deposit, it keeps reserves of \$2,000, and had already created loans of \$8,000. All monetary transactions are made by check, no one uses currency. Furthermore, Fantasia’s central bank has a required reserve of 10% of deposits.
a) Suppose the bank lends out all of the excess reserves (keeps only the required reserve), and people do not keep cash, how much does the money supply change due to the new loan?
b) Due to the upcoming New Year holiday, people in Fantasia increased their cash holding from zero to 20% of total deposits (while the bank still keep zero excess reserve); what is the money multiplier now?
c) And then, following b); at the same time, suppose the bank anticipated a withdrawal from a client, so it decided to hold more excess reserves, about 15% of total deposits to anticipate some cash withdrawals, what is the multiplier now?
3. Use the liquidity preference model (Ms-Md) to describe the effect of the following events:
a) the FOMC engages in an open-market purchase of T-bills.
b) The aggregate price level increases.
c) The housing market has declined the past two years, and households reduce consumption
d) Your grandmother (and her friends) is worried about identity theft, so she now is using more cash and even keep some cash in the cookie jar in the kitchen
4. Show in a T-account for each of the following event (both the Fed’s T-account and the Banks’ T-account):
a) The Fed purchases \$200million value of T-bills via its open-market operation.
b) John deposits \$20,000 into his checking account with a bank; the required reserve ratio is 10%, and the bank uses the money to buy T-bills.
5. Use Taylor Rule to determine the targeted federal funds rate (imagine you work for the Fed and help determine the rate), based on these data:
a) the GDP is higher than its long-run path (inflationary gap) by 2%, and the GDP deflator shows a 5% increase in price level. Other variables remain constant.
b) The short-run GDP equilibrium is exactly on its long-run path (equals to potential output), and the GDP deflator shows a 4% decrease in price level. Other variables remain constant.

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