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Problem Set 4


Complete all questions listed below. Clearly label your answers. 




1.      What determines whether a financial asset is included in the M1 money supply? Why are interest-earning checkable deposits included in M1, whereas interest-earning savings accounts and Treasury bills are not?




2.      Why are banks able to maintain reserves that are only a fraction of the demand and savings deposits of their customers? Is your money safe in a bank? Why or why not?




3.      What is the Federal Funds Interest rate? if the Fed wants to use open market operations to lower the federal funds rate, what action should it take?




4.   Suppose that the reserve requirement is 10 percent and the balance sheet of the People’s National Bank looks like the accompanying example.




a.       What are the required reserves of People’s National Bank? Does the bank have any excess reserves?


b.      What is the maximum loan that the bank could extend?


c.       Indicate how the bank’s balance sheet would be altered if it extended this loan (show the new t-account).


d.      Suppose that the required reserves were 20 percent. If this were the case, would the bank be in a position to extend any additional loans? Explain.






Vault Cash $20,000

Checking deposits $200,000

Deposits at Fed $30,000

Net Worth $15,000

Securities $45,000


Loans $120,000





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