2012 Macroeconomics Exam FRQ #2

2012 Macroeconomics Exam FRQ #2

Watch me answer it on youtube https://youtu.be/WPH4Pmot8aM

(a) What is the reserve requirement?

If demand deposits are $100,000 and required reserves are $10,000 we can assume that the reserve requirements are 10%.

Answer - One point is earned for calculating the correct reserve requirement of 10 percent

($10,000/$100,000). 

(b) Assume that Luis withdraws $5,000in cash from his checking account at Mi Tierra Bank.

(i) By how much will Mi Tierra Bank's reserves change based on Luis's withdrawal.

So, Luis deposited $100,000 into the bank, of which 10% is required by the Fed to be held as required reserves. The banks has loaned out $85,000 dollars of the amount Luis deposited into the bank, leaving $5,000 in cash on hand,, called excess reserves.

If Luis takes out $5,000 then reserves will decrease by $5,000.

Answer - One point is earned for stating that total bank reserves will decrease by $5,000 

(ii) What is the initial effect of the withdrawal on the M1 measure of money supply? Explain.

First, you must know what the M1 money supply actually is.. 

Monetary Policy Cheat Sheet

M1 is paper money, coins and checkable deposits,,, no matter if the money is in the bank as checkable deposits or in Luis's pocket as cash it doesn't effect the M1 money supply. I guess if Luis took the money and burned it,, then the M1 level of the money supply would have been changed.

Short of burning the money,, the M1 doesn't change from bank  (checkable deposits) to customer (cash).

Answer - One point is earned for stating that the $5,000 withdrawal has no effect on the M1 measure of the money supply because it only changes the composition of M1 between cash and demand deposits. 

(iii) As a result of the withdrawal, what is the new value of the excess reserves on the balance sheet of the Mi Tierra Bank, based on the reserve requirements from part (a).

This is tricky,, you must decrease the Demand deposits by the $5,000 and decrease excess reserves by $5,000 and then add back to excess reserves the amount $500 that doesn't need to be held in reserved requirements due to the $5,000 withdrawal.

Answer - One point is earned for stating that the new value of the excess reserves is $500.