ECN 135 Homework 3 -The following are balance sheet items

ECN 135 Fall 2016Homework #3Due by 5 PM Wednesday November 30 Assignment must be uploaded to Canvas as a pdf file or MS WordIt is ok to scan a hand-written document, but scan to pdf only (no jpeg or camera photo, etc.)Also, scan must be a single file (no multiple documents or files).Question 1)The following are balance sheet items for two entities: the Central Bank and A CommercialBank.Central Bank: Discount Loans $35 B, Currency $60 B, Government Securities $55 B,Net Worth: $10 B, and Reserves $20 BCommercial Bank: Checkable Deposits $100 B, Government Securities $80 B,Loans $50 B, Net Worth $15 B, Reserves $20 B, Borrowings (fromCentral Bank) $35 B The reserve requirement is 10%. In answering below, be sure to clearly state any assumptionsyou make.a) Build a Balance Sheet for each bank. If the Central Bank calls in $10 B indiscount loans, explain in words what happens to each balance sheet initially. b) Calculate the effect of the Central Bank calling in $10 B in discount loans on the moneysupply. c) Discuss 1 additional factor that affects the money supply (M1) besides the FederalReserve and briefly explain how it does so. Question 2)For each of the following, draw a supply and demand diagram for the overnight interest rate.Also, provide a brief written explanation of your answer and what will happen to the overnightinterest rate.a) Currently the equilibrium overnight rate is 4% and there is $0B in borrowed reserves.The rate the Central Bank charges for overnight loans is 5% and pays 4% for reserves.Show what will happen if the economy booms. b) Currently the equilibrium overnight rate is 3% and there is $0B in borrowed reserves.The rate the Central Bank charges for overnight loans is 3% and it pays 3% on reserves.Show what will happen if the Fed sells bonds to banks. c) Currently the equilibrium overnight rate is 4% and there is $0B in borrowed reserves.The rate the Central Bank charges for overnight loans is 5%. The Central Bank also pays3% on any deposits banks keep at the Central Bank. Show what will happen if theeconomy enters into recession.Page 1 of 2 For Questions 3) and 4). True/False Explain Questions: For each statement, state whether youbelieve the statement is true or false. Provide a brief explanation of your reasoning.Question 3)a)If the Federal Reserve commits to money supply growth of 2% per year, then theeconomy enters recession, it would be time consistent to raise the growth rate to 5%.b)If households decide to hold more currency and pull money out of banks, this has noimmediate effect on the money supply.c)If households decide to hold more currency and pull money out of banks, this has aneffect on the money supply over time.Question 4)a)The ability of the Federal Reserve to set the growth rate of the money supply is a goodexample of goal independence.b)When setting monetary policy, the Federal Open Market Committee targetsmonetary aggregates like M1.c)Countries that use inflation targeting attempt to set the inflation rate to 0.Question 5)Quick Answers. For each of the following you only need to provide a one or two-word response (chooseone of the underlined phrases for each statement). a) Historically in the United States southern interests typically did or did not support theSecond Bank of the United States. b) According the political business cycle theory, there would be a tendency toincrease/decrease the money supply before an election. c) All else the same, an increase in Treasury deposits to the Fed will increase/decrease themonetary base. d) Over the course of 1931-1934, the currency ratio in the United Statesincreased/decreased. e) Targeting non-borrowed reserves/federal funds rate will tend to increase the volatility ofinterest rates in the economy. f) Open market operations to offset a change in reserves demand would be an example of adefensive/dynamic open market operation. g) If inflation becomes more sensitive to changes in the output gap, this likely means thatbeta is higher/lower. h) Implementing inflation targeting is thought to increase/decrease the transparency of theCentral Bank. Page 2 of 2