Part A
1. Why is the money multiplier in the United States smaller than the inverse of the required reserve ratio? Provide one (1) reason.
2. Explain why depositing cash into a checking account does not change the money supply. Provide one (1) supporting fact.
3. Explain why the money supply does not change when one individual writes a check to another. Provide one (1) supporting fact.
Part B
1. Describe one (1) reason why the flexibility of wages and prices tend to favor the Keynesian economic view in the short run and one (1) reason why the flexibility of wages and prices tend to favor the classical economic view in the long run.
2. Refer the figure below and explain what happens in each graph (A, B, and C) when an economy is moving from a recession (point a) back to full employment.
C11.V.4.1 Macroeconomics
Assignment 08,
Money Supply and Economic view in Macroeconomics
The money multiplier is the amount of money which banks creates from the reserves of money. In United States, the money multiplier has usually been between two and three -much smaller than the value of 10 implied by a simple formula. The reason for why money multiplier is smaller is a formula estimate that all loans made to the customer directly into checking accounts. But in real, people take their loans in cash. If the more money people hold in cash and less deposit on bank, bank do not have money to lend out to its customers. By this way, the decrease in money multiplier happens. But in reserve ratio, money moves from one bank to another bank to create money. Reserve ratio is defined as the ratio of reserves to deposits. For example, someone deposits $1000 in cash to open a checking account in a Bank A. Let's assume bank keeps 10% of the deposit as reserves. Now, the Bank A keep $100 in reserves and lend out $900. Suppose Bank A loans the amount of money to a businessman. A businessman invest his borrowed money to open a restaurant and pays to supplier for equipment. That supplier who accept the amount of $900 from a businessman deposits in a Bank B. Then, Bank B reserves $90 and loans the amount of $810 to someone and this process goes on.
Money supply is defined as the analysis of the money by developing different policies and controlling interest rates which change (increase and decrease) the amount of money in an economy. The Government or the central bank of the nation collect, record and publish the data of money supply systematically. Money supply can be cash, coins and deposited balances in a saving and checking account and these types of transaction do not change the money supply. The cash deposited into the checking account bring down the money held by a public by actual the amount of money the checking account increased it. The interest in checking account is provide only if the balances are high. When the money supply effect price level, inflation and the cycle of the business, public and private sector are performed to analysis. In United States of America, the power to change in money supply is with the Federal Reserve which is the central bank of the country.
The Federal Reserve can change (increase and decrease) the money supply through open market operation. An individual or a firm can not change the supply of money when they write a checks to one another because the total amount of reserves in the system is unchanged, the money supply cannot increase. All the banks in a country are under control of the central bank. The total amount of money what the bank collects should be reserve in a central bank. The central bank also lend out the money to the other banks of the country. It is the one who has a power to increase or decrease the economic condition of the country. All the exchange rates and the value of money in a country are analyzed by the process the viewing the economic status of the nation. The supply of money circulating in an economy and the change in interest rates happens by only the policy actions made by the central bank. The change in money supply is not in the hand of one individual, a company or a bank. It is the decision of the Board of Governors including the chairman of the central bank.
In macroeconomics, the short run is a certain period of time in which wages and prices are sticky and do not change or do not change very much immediately in response to change in demand. It favor the Keynesian economic view where wages and prices are not fully flexible in a short period. The British economist John Maynard Keynes who developed the Keynesian economics where an economic theory of total investing money in the economy and its results on output and inflation is explain. According to his view, the demand could fall short of production if wages and prices are not adjustable. GDP is figured out by the current demand for goods and services in the economy in short run. But the long run in macroeconomics is not similar to short run. In long run the wages and prices are fully flexible in an economy. Full employment is performed in the long run by which output can't increase in response to change in demand. It supports the classical economic view in macroeconomics. Adam Smith was the first classical economist. According to the classical economic view, the demand for goods and services are sufficient when the economy was at full employment and the wages and prices adjust rapidly to change in demand and supply in a long period of time. GDP is figured out by the labor supply, the stock of capital and technological process in long run.
According to the figure when an economy is moving from a recession back to full employment, at first the price level falls as shown in Panel A with AD-AS diagram, stimulating output. Secondly, as shown in Panel B, the lower price level decreases the demand for money and leads to lower interest rates. As the price level decreases from P0 to P1, the money demand shifts to the left from Md0 to Md1. Continuously, interest rates fall from r0 to r1, and the increase in investment spending by the decreasing interest rates from I0 to I1. In an economy, if the investment spending increases, the total demand for goods and services also increases and along with the aggregate demand curve the economy moves down as it returns to full employment.
References
O'Sullivan, Steven M. Sheffrin, & Stephen J. Perez (2014). Macroeconomics (8th Ed.). New Jersey: Pearson.
Peter Sorensen & Hans Whitta-Jacobsen (2010). Introducing Advanced Macroeconomics: Growth and Business Cycles (2nd Ed.). New York: McGraw-Hill Education.
N. Gregory Mankiw (2011). Principles of Macroeconomics (6th Ed.). Kentucky: South-Western Cengage Learning.
Paul Krugman & Robin Wells (2012). Macroeconomics (3rd Ed.). Duffield: Worth Publishers.
