ECON 202 Principles of Macroeconomics
Assignment 8 (Maximum Points: 4)
Please answer the following problem sets.
1. Explain whether each of the following events increases or decreases the money supply.
a. The Fed buys bonds in open-market operations.
b. The Fed reduces the reserve requirement.
c. The Fed increases the interest rate it pays on reserves.
d. Citibank repays a loan it had previously taken from the Fed.
e. After a rash of pickpocketing, people decide to hold less currency.
f. Fearful of bank runs, bankers decide to hold more excess reserves.
g. The FOMC increases its target for the federal funds rate.

2. Happy Bank starts with $200 in bank capital. It then accepts $800 in deposits. It keeps 12.5 percent (1/8th) of deposits in reserve. It uses the rest of its assets to make bank loans.
a. Show the balance sheet of Happy Bank.
b. What is Happy Bank’s leverage ratio?
c. Suppose that 10 percent of the borrowers from Happy Bank default and that these bank loans become worthless. Show the bank’s new balance sheet.
d. By what percentage do the bank’s total assets decline? By what percentage does the bank’s capital decline? Which change is larger? Why?

3. The Fed conducts a $10 million open-market purchase of government bonds. If the required reserve ratio is 10 percent, what are the largest and smallest possible increases in the money supply that could result? Explain. (Hint: Use money multiplier)