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Chapter 29: Problem 1

For each of the following transactions, what is the initial effect (increase or decrease) on M1? On M2? a. You sell a few shares of stock and put the proceeds into your savings account. b. You sell a few shares of stock and put the proceeds into your checking account. c. You transfer money from your savings account to your checking account. d. You discover \(\$ 0.25\) under the floor mat in your car and deposit it in your checking account. e. You discover \(\$ 0.25\) under the floor mat in your car and deposit it in your savings account.

Short Answer

Expert verified
Answer: Transferring money from a savings account to a checking account causes an increase in M1, as checking accounts are part of M1. There is no overall change in M2, as the total amount of money hasn't changed, just its allocation within M2 components.

Step by step solution

01

a. Selling stock and putting proceeds into savings account

Neither M1 nor M2 is affected by selling the stock, as stocks are not considered part of the money supply. However, when the proceeds are deposited into a savings account, it will cause an increase in M2 since savings accounts are part of M2 but not M1. So, there is no effect on M1 and an increase in M2.
02

b. Selling stock and putting proceeds into checking account

Selling the stock does not affect either M1 or M2. When the proceeds are deposited into a checking account, this will increase both M1 and M2, as checking accounts are part of M1, and by extension, part of M2.
03

c. Transferring money from savings account to checking account

When transferring money from a savings account to a checking account, you are moving money from one component of M2 to another. This will cause an increase in M1 since checking accounts are part of M1, and a decrease in the savings account component of M2. However, the overall amount of M2 remains unchanged as the total amount of money hasn't changed, just its allocation within M2 components.
04

d. Finding $0.25 and depositing it into checking account

When you discover \(0.25 and deposit it into your checking account, this will increase both M1 and M2. The physical currency is part of M1, and when it is deposited into a checking account, it remains in M1. Since M2 includes everything in M1, M2 will also increase by \)0.25.
05

e. Finding $0.25 and depositing it into savings account

Similar to part d, finding the $0.25 will not affect M1 or M2 until it is deposited. When it is deposited into a savings account, it will cause an increase in M2, as savings accounts are part of M2 but not M1. There is no effect on M1 and an increase in M2.

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Most popular questions from this chapter

In Westlandia, the public holds \(50 \%\) of \(\mathrm{M} 1\) in the form of currency, and the required reserve ratio is \(20 \%\). Estimate how much the money supply will increase in response to a new cash deposit of \(\$ 500\) by completing the accompanying table. (Hint: The first row shows that the bank must hold \(\$ 100\) in minimum reserves \(-20 \%\) of the \(\$ 500\) deposit- against this deposit, leaving \(\$ 400\) in excess reserves that can be loaned out. However, since the public wants to hold \(50 \%\) of the loan in currency, only \(\$ 400 \times 0.5=\$ 200\) of the loan will be deposited in round 2 from the loan granted in round 1.) How does your answer compare to an economy in which the total amount of the loan is deposited in the banking system and the public doesn't hold any of the loan in currency? What does this imply about the relationship between the public's desire for holding currency and the money multiplier?

There are three types of money: commodity money, commodity-backed money, and fiat money. Which type of money is used in each of the following situations? a. Bottles of rum were used to pay for goods in colonial Australia. b. Salt was used in many European countries as a medium of exchange. c. For a brief time, Germany used paper money (the "Rye Mark") that could be redeemed for a certain amount of rye, a type of grain. d. The town of Ithaca, New York, prints its own currency, the Ithaca HOURS, which can be used to purchase local goods and services.

Although the U.S. Federal Reserve doesn't use changes in reserve requirements to manage the money supply, the central bank of Albernia does. The commercial banks of Albernia have \(\$ 100\) million in reserves and \(\$ 1,000\) million in checkable deposits; the initial required reserve ratio is \(10 \%\). The commercial banks follow a policy of holding no excess reserves. The public holds no currency, only checkable deposits in the banking system. a. How will the money supply change if the required reserve ratio falls to $5 \%$ ? b. How will the money supply change if the required reserve ratio rises to $25 \%$ ?

The Congressional Research Service estimates that at least \(\$ 45\) million of counterfeit U.S. \(\$ 100\) notes produced by the North Korean government are in circulation. a. Why do U.S. taxpayers lose because of North Korea's counterfeiting? b. As of December 2014 , the interest rate earned on one-year U.S. Treasury bills was \(0.13 \%\). At a \(0.13 \%\) rate of interest, what is the amount of money U.S. taxpayers are losing per year because of these \(\$ 45\) million in counterfeit notes?

Show the changes to the T-accounts for the Federal Reserve and for commercial banks when the Federal Reserve buys \(\$ 50\) million in U.S. Treasury bills. If the public holds a fixed amount of currency (so that all loans create an equal amount of deposits in the banking system), the minimum reserve ratio is $10 \%$, and banks hold no excess reserves, by how much will deposits in the commercial banks change? By how much will the money supply change? Show the final changes to the T-account for commercial banks when the money supply changes by this amount.
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