Economics 470/570

Fall 2008

Homework #4

Due 10/30/2008

1. Suppose the Fed sells $1,000 worth of securities to the public. Assuming that the reserve requirement is 25%, use t-accounts to show the resulting multiple deposit contraction (carry the t-accounts out through three steps). Use the multiplier formula to calculate the total fall in bank deposits.

2. Derive the money multiplier when C ≠ 0 and ER ≠ 0. Explain why it is smaller than the simple money multiplier.

3. Show, using graphs, how (a) open market operations, (b) borrowing from the Fed, and (c) changes in reserve requirements affects the federal funds rate.

4. Show graphically how an increase in financial market risk impacts the federal funds rate, and how the Fed would respond in order to return the federal funds rate to its target value.