Deck 31: Fiscal Policy, Deficits, and Debt

Question 1

Assume that the following asset values (in millions of dollars) exist in Ironmania: Federal Reserve Notes in circulation =$700; Money market mutual funds (MMMFs) held by individuals = $400; Corporate bonds = $300; Iron ore deposits = $50; Currency in commercial banks = $100; Savings deposits, including money market deposit accounts (MMDAs) = $140; Checkable deposits = $1500; Small denominated (less than $100,000) time deposits = $100; Coins in circulation =$40.
a. What is M 1 in Ironmania
b. What is M 2 in Ironmania

Answer 1

(a) M1 is the narrowest definition of the money supply, and only includes currency and checkable deposits. Here, Federal Reserve Notes are part of the currency, along with coins. The currency in this economy is thus equal to
. Note that we do not count currency held by commercial bank as part of currency, because it will result in double counting of M1. Next, we see that there is $1500 of checkable deposits in the economy. Hence, M1 in this economy is equal to currency plus checkable deposits, or $740 plus $1500, which is equal to $2240.
(b) M2 includes everything in M1 along with near-monies , such as saving deposits (which includes money market deposit accounts), small-denominated (less than $100,000) time deposits, and money market mutual funds held by individuals. In this economy, we see that saving deposits is $140, small denominated time deposits are $100, and Money Market Mutual Funds are $400. Therefore, we have:
Note that iron ore is not a type of near-monies, and thus is not counted in M2.

Question 2

What are the three basic functions of money Describe how rapid inflation can undermine money's ability to perform each of the three functions.

Answer 2

Three basic function of money are:-
1. Medium of exchange- The most important function of is that it serves as a medium of exchange. Money commands general purchasing power to purchase goods and services which people want. Money is generally and widely accepted as medium through which most of the purchase or sales are made.
2. Unit of Account- The second important function of money is that it acts as a common unit of account or measure of value. Money serves as a unit of measurement in terms of which the values of all goods and services are measured and expressed. When we express the value of a commodity in terms of money, it is known as price.
3. Store of Value- Money also serves as a store of value, i.e., people can keep their wealth in the form of money. Money is a perfectly liquid asset, i.e., it is ready and generally acceptable means of payment. Money allows us to store purchasing power which can be used at any time in future to purchase goods and services, including other assets.
The rapid inflation will undermine the basic function of medium of exchange because people will again shift barter system.
Drastic inflation will reduce money's use as a measure value; inflation will depreciate the value of money. The country will only employ money as a unit of account when purchasing power is relatively stable. Due to drastic decrease in the value of money, the price fixers will not be able to fixe price of their goods.
Money's usefulness as a store of value is destroyed in a drastic inflation. People will only use money as a store of value when there is no depreciation in the value of money. People will loose their confidence in the value of money.

Question 3

Assume that Jimmy Cash has $2000 in his checking account a Folsom Bank and uses his checking account card to withdraw $200 of cash from the bank's ATM machine. By what dollar amount did the M 1 money supply change as a result of this single, isolated transaction

Answer 3

Remember that the definition of M1 is:
.
We see that the person withdrawing $200 from his checking account will cause checkable deposits in the economy to go down by $200, but will cause currency in the economy to go up by $200. Therefore, the net effect on M1 is zero. In other words, this transaction will not cause the M1 to change in the economy.

Question 4

Which two of the following financial institutions offer checkable deposits included within the M 1 money supply: mutual fund companies; insurance companies; commercial banks; securities firms; thrift Institutions Which of the following items is not included in either M 1 or M 2: currency held by the public; checkable deposits; money market mutual fund balances; small-denominated (less than $100,000) time deposits; currency held by banks; savings deposits

Question 5

Suppose the price level and value of the US. dollar in year 1 are 1 and $1, respectively. If the price level rises to 1.25 in year 2, what is the new value of the dollar If, instead, the, price level falls to.50, what is the value of the dollar

Question 6

What are the components of the M 1 money supply What is the largest component Which of the components of M 1 is legal tender Why is the face value of a coin greater than its intrinsic value What near-monies are included in the M 2 money supply

Question 7

Suppose that Lady Gaga goes to Las Vegas to play poker and at the last minute her record company says it will reimburse her for 50 percent of any gamblingthat she incurs. Will Lady Gaga wager more or less as a result of the reimbursement offer What economic concept does your answer illustrate

Question 8

Explain and evaluate the following statements:
a. The invention of money is one of the great achievements of humankind, for without it the enrichment that comes from broadening trade would have been impossible.
b. Money is whatever society says it is.
c. In the United States, the debts of government and commercial banks are used as money.
d. People often say they would like to have more money, but what they usually mean is that they would like to have more goods and services..
e. When the price of everything goes up, it is hot because everything is worth more but because the currency is worth less.
f. Any central bank can create money; the trick is to create enough, but not too much, of it.

Question 9

Assume that securitization combined with borrowing and irrational exuberance in Hyperville have driven up the value of existing financial securities at a geometric rate, specifically from $2 to $4 to $8 to $16 to $32 to $64 over a six-year time period. Over the same period, the value of the assets underlying the securities rose at an arithmetic rate from $2 to $3 to $4 to $5 to $6 to $7. If these patterns hold for decreases as well as for increases, by how much would the value of the financial securities decline if the value of the underlying asset suddenly and unexpectedly fell by $5

Question 10

What "backs" the money supply in the United States What determines the value (domestic purchasing power) of money How does the purchasing power of money relate to the price level Who in the United States is responsible for maintaining money's purchasing power

Question 11

How is the chairperson of the Federal Reserve System selected Describe the relationship between the Board of Governors of the Federal Reserve System and the 12 Federal Reserve Banks. What is the purpose of the Federal Open Market Committee (FOMC) What is its makeup

Question 12

The following are two hypothetical ways in which the Federal Reserve Board might be appointed. Would you favour either of these two methods over the present method Why or why not
a. Upon taking office, the U.S. president appoints seven people to the Federal Reserve Board, including a chair. Each appointee must be confirmed by a majority vote of the Senate, and each serves the same 4-year term as the president.
b. Congress selects seven members from its ranks (four from the House of Representatives and three from the Senate) to serve at congressional pleasure as the Board of Governors of the Federal Reserve System.

Question 13

What is meant when economists say that the Federal Reserve Banks are central banks, quasi-public banks, and bankers' banks

Question 14

Why do economists nearly uniformly support an independent' Fed rather than one beholden directly to either the president or Congress

Question 15

Identify three functions of the Federal Reserve -of your choice, other than its main role of controlling the Supply of money.

Question 16

How do each of the following relate to the financial crisis of 2007-2008: declines in real estate values, subprime mortgagemortgage-backed securities, AIG.

Question 17

What is TARP and how was it funded What is meant by the term "lender oflast resort" and how does it relate to the financial crisis of 2007-2008 How do government and Federal Reserve emergencyrelate to the concept of moral hazard

Question 18

What are the major categories of firms that make up the U.S. financial services industry Are there more or fewer banks today than before the start of the financial crisis of 2007-2008 Why are the lines between the categories of financial firms even more blurred than they were before the crisis How did the Wall Street Reform and Consumer Protection Act of 2010 try to address some of the problems that helped cause the crisis

Question 19

LAST WORD How does a debit card differ from a credit card How does a stored-value card differ from both Suppose that a person has a credit card, debit card, and stored-value card. Create a fictional scenario in which the person uses all three cards in the same day. Explain the person'sfor using one card rather than one of the others for each transaction. How do Fedwire and ACH transactions differ from credit card, debit card, and stored-value card transactions