Problems

36 . Explain what would happen if banks were notified they had to increase their required reserves by one percentage point from, say, 9% to10% of deposits. What would their options be to come up with the cash? 37 . A well-known economic model called the Phillips Curve (discussed in The Keynesian Perspective chapter) describes the short run tradeoff typically observed between inflation and unemployment. Based on the discussion of expansionary and contractionary monetary policy, explain why one of these variables usually falls when the other rises. 38 . How does rule-based monetary policy differ from discretionary monetary policy (that is, monetary policy not based on a rule)? What are some of the arguments for each? 39 . Is it preferable for central banks to primarily target inflation or unemployment? Why? 40 . If for some reason the IORB increased and momentarily stayed above the FFR, why would the FFR ultimately increase as well? Explain this process in detail.

Problems

41 . Suppose the Fed conducts an open market purchase by buying $10 million in Treasury bonds from Acme Bank. Sketch out the balance sheet changes that will occur as Acme converts the bond sale proceeds to new loans. The initial Acme bank balance sheet contains the following information: Assets – reserves 30, bonds 50, and loans 50; Liabilities – deposits 100 and equity 30. 42 . Suppose the Fed conducts an open market sale by selling $10 million in Treasury bonds to Acme Bank. Sketch out the balance sheet changes that will occur as Acme restores its required reserves (10% of deposits) by reducing its loans. The initial balance sheet for Acme Bank contains the following information: Assets – reserves 30, bonds 50, and loans 250; Liabilities – deposits 300 and equity 30. 43 . All other things being equal, by how much will nominal GDP expand if the central bank increases the money supply by $100 billion, and the velocity of money is 3? (Use this information as necessary to answer the following 4 questions.) 44 . Suppose now that economists expect the velocity of money to increase by 50% as a result of the monetary stimulus. What will be the total increase in nominal GDP? 45 . If GDP is 1,500 and the money supply is 400, what is velocity? 46 . If GDP now rises to 1,600, but the money supply does not change, how has velocity changed? 47 . If GDP now falls back to 1,500 and the money supply falls to 350, what is velocity?

FIGURE 16.1Trade Around the World Is a trade deficit between the United States and the European Union good or bad for the U.S. economy? (Credit: modification of “US Dollar banknotes” by Milad Mosapoor/Wikimedia Commons, Public Domain)

In this chapter, you will learn about:

• How the Foreign Exchange Market Works
• Demand and Supply Shifts in Foreign Exchange Markets
• Macroeconomic Effects of Exchange Rates
• Exchange Rate Policies

BRING IT HOME Is a Stronger Dollar Good for the U.S. Economy? From 2002 to 2008, the U.S. dollar lost more than a quarter of its value in foreign currency markets. On January 1, 2002, one dollar was worth 1.11 euros. On April 24, 2008 it hit its lowest point with a dollar being worth 0.64 euros. During this period, the trade deficit between the United States and the European Union grew from a yearly total of approximately 85.7 billion dollars in 2002 to 95.8 billion dollars in 2008. Was this a good thing or a bad thing for the U.S. economy? We live in a global world. U.S. consumers buy trillions of dollars worth of imported goods and services each year, not just from the European Union, but from all over the world. U.S. businesses sell trillions of dollars’ worth of exports. U.S. citizens, businesses, and governments invest trillions of dollars abroad every year. Foreign investors,