Macroeconomics II: Money and Banking

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Questions and Answers

What is one potential solution to the problem of bank runs?

Increasing interest rates on deposits

Government-provided deposit insurance (correct)

Limiting withdrawals during economic crises

Implementing strict lending regulations

What is a main drawback of deposit insurance?

It eliminates the need for financial regulation

It reduces the overall money supply

It guarantees higher returns for depositors

It creates a moral hazard problem (correct)

What amount is the limit for deposit insurance in the Eurozone?

€250,000

€500,000

€50,000

€100,000 (correct)

What happened on March 9, 2023, at SVB?

Depositors withdrew 25 percent of total deposits Signup and view all the answers

In the Diamond-Dybvig model, what does the government guarantee to each depositor?

A specific amount as defined in the banking contract Signup and view all the answers

What is the primary objective of the Eurosystem as established by the Treaties?

Maintaining price stability Signup and view all the answers

What does the dual mandate of the Federal Reserve include?

Controlling inflation and maximizing employment Signup and view all the answers

Why is a 2% inflation target considered necessary?

It encourages investment and stabilizes the economy Signup and view all the answers

What is a main concern if inflation is too high?

It generates higher volatility and uncertainty Signup and view all the answers

Which of the following is NOT a reason to avoid high inflation according to the content?

Sustained economic growth Signup and view all the answers

What negative impact does high inflation have according to the content?

It reduces investment due to uncertainty Signup and view all the answers

When did the ECB establish its inflation targeting system?

1998 Signup and view all the answers

What is a pro of price stability mentioned in the content?

It prevents extreme market fluctuations Signup and view all the answers

What is the correct reserve ratio if a bank holds 20% of total deposits as reserves?

0.20 Signup and view all the answers

If the total deposits in Bank A are 1000e, how much money does Bank A loan out?

800e Signup and view all the answers

The total money supply (M) in the economy is calculated using which of the following formulas?

C + D Signup and view all the answers

Why do banks create money in a fractional-reserve banking system?

By holding a fraction of deposits as reserves. Signup and view all the answers

After a borrower from Bank A uses the 800e to make a purchase, what happens to the money supply when the merchant deposits this money into Bank B?

Money supply increases. Signup and view all the answers

In the context of the provided banking scenario, what does R represent in Bank A’s balance?

Reserves held. Signup and view all the answers

What is the total amount of reserves held by Bank A if the reserve ratio is 20%?

200e Signup and view all the answers

If Bank B receives a deposit of 800e from a transaction after a loan from Bank A, what is Bank B's reserve holding at a reserve ratio of 20%?

160e Signup and view all the answers

What is the primary focus of the relationship between money and prices in monetary economics?

The neutrality of money Signup and view all the answers

According to Baumol-Tobin's theory, what factor influences the demand for money?

Transaction costs associated with asset exchanges Signup and view all the answers

In Sidrauski's model, what is the structure of the economy described?

A pure-exchange economy lasting two periods with no production Signup and view all the answers

How is money characterized in relation to other assets in the economy?

Money is like any other asset used to transfer resources intertemporally Signup and view all the answers

What is meant by 'pure-exchange economy' as referred to in Sidrauski’s model?

An economy where only trade occurs with zero production Signup and view all the answers

What is the implication of having identical consumers in Sidrauski's model?

It allows for a simplified analysis of saving behavior Signup and view all the answers

What is the objective of the consumer in Sidrauski's model?

To maximize utility from consumption and money holdings Signup and view all the answers

What does the monetary authority do at the beginning of period 1 in Sidrauski's model?

Distributes total money supply equally among consumers Signup and view all the answers

In the context of Sidrauski's Model, which equation correctly represents the consumer's budget constraint?

p1 c1 + p1 s = p1 y1 + M̄ Signup and view all the answers

What is the significance of having only one consumption good in Sidrauski’s model?

It simplifies the economic dynamics for the study Signup and view all the answers

What does $M_t$ represent in Sidrauski's model?

The money the consumer wants to have at the end of period t Signup and view all the answers

Which term in the utility function indicates a future preference in Sidrauski's consumer problem?

β (ln c2 + ln m2) Signup and view all the answers

What does the parameter $eta$ represent in the consumer's utility function?

The discount factor reflecting time preference Signup and view all the answers

In the first budget constraint, which variable is associated with savings?

s Signup and view all the answers

Which of the following is NOT included in the intertemporal budget constraint formulation?

Past savings (s) Signup and view all the answers

In Sidrauski's model, how does the interest rate ($i$) affect the consumer's budget constraint?

It influences future consumption and savings behavior Signup and view all the answers

What decision may customers make at the gate regarding their ticket purchase?

Turn around and leave without buying Signup and view all the answers

What effect does a decrease in the money supply have?

Reduces customer spending Signup and view all the answers

What is a potential consequence of operators noticing that the park is relatively empty?

They might decide to reduce employment levels Signup and view all the answers

What happens when operators perceive a recession in terms of output and employment?

Both output and employment decrease Signup and view all the answers

Which approach is suggested for modeling the demand for money?

Demand can be modeled using three different approaches Signup and view all the answers

How might extra employees hired for a busy day respond to decreased customer volume?

They may be sent home early due to low attendance Signup and view all the answers

What might operators infer from reduced spending by customers?

Their business outlook may become pessimistic Signup and view all the answers

What action can be cited as potentially creating a boom in the economy?

Creating a continuous influx of money supply Signup and view all the answers

Study Notes

Macroeconomics II: Money, Monetary Policy, and Banks

This course covers money, monetary policy, and banks in macroeconomics.
Supplementary readings are suggested for further study, including works by Carl E. Walsh, Ben S. Bernanke, T. Geithner, J. Tirole, A. Metrick, Kenneth S. Rogoff, and Tano Santos.
The course previously covered real variables, including consumption, savings, production, wages, and real interest rates.
Nominal variables, measured in currency units, are now introduced, including nominal wages, nominal interest rates, inflation, and so on.
The key questions are: Why is money relevant? What are the macroeconomic effects of expansionary monetary policy?

Money

Real variables (e.g., consumption, wages) have already been dealt with in terms of the consumption good.
Introducing money now leads to nominal variables (e.g., nominal wages, inflation).

Lucas' Story

This is an economic model used as a lab to examine the effects of contractionary monetary policy in a simple economy (Tibidabo).
The model presents a closed economy represented by a simplified amusement park, which has its own monetary system.
Visitors use euros to buy tickets at a fixed rate.
Goods are priced in tickets acquired using euros.

First Experiment

The scenario is adjusting the exchange rate of € to a ticket value (e.g., 4 tickets per € instead of 2), and the price of rides to adjust accordingly. Increasing the money supply from 2 to 4 tickets per euro.
This increases money supply by 100%.
The equilibrium of prices and quantities will likely not change significantly.

Second Experiment

The price of a ticket is increased from 50 cents to 75 cents, but the prices of rides and food remain the same.
The money supply for the park will decrease in this case.
Customers may opt to either turn around (not buy anything), buy fewer tickets from their budget, or buy the same number of tickets as before.

Sidrauski's Model

A two-period, pure-exchange economy without production is detailed.
A large number of identical consumers, allowed to save, are part of the model.
There is only one consumption good, and each consumer has an endowment in consumption units.
A monetary authority provides each consumer with a starting amount of money.
The money supply is equal to the total amount of money given to consumers.
Prices for consumption goods (p₁ and p₂), the inflation rate (π), and the nominal interest rate (i) are key part of the model..
Consumers preferences follow In(C₁)+ In(m₁)+ β(In(C₂)+In(m₂)).

Consumer's Problem

This is the optimization problem for consumers.
The Lagrangian for this problem.

Definition of Monetary Policy

The monetary policy is the control of the money supply.
Central banks control the money supply generally using open market operations.
The three monetary aggregates for the Eurozone are M1 (currency and checking accounts); M2 (M1 + deposits with maturity ≤2 yrs or redeemable on short notice); and M3 (M2 + certain marketable instruments with maturity ≤2 years).

Monetary Policy and the ECB

The primary objective of the ECB (European Central Bank) is to maintain price stability.
The ECB is governed by the Governing Council.
The inflation rate, below 2%, is the objective.

The Role of Commercial Banks

Commercial banks are integral in the money supply.
Central banks influence money supply via open market operations.
Households and banks determine demand deposits.
Different scenarios (no banks, 100% reserve banking, and fractional-reserve banking) will show how money supply changes. The amount of reserves directly controls how much money is created.

Money Multiplier

The amount of money generated by each reserve euro is expressed using the money multiplier.
The Central Bank controls the monetary base (B = C + R)

2019 Final Exam Question

Find the monetary base, deposits, and the money multiplier given M=100, C=10, and rr=0.2.

Main Properties of Assets

Rate of return: the ratio of payoff to initial investment.
Risk: volatility of rate of return.
Maturity: time until payoff.
Liquidity: how quickly an asset can be converted into cash.

Financial Intermediation

Financial markets redistribute savings to borrowers.
Financial intermediaries (e.g., banks, mutual funds) transform assets and process information.

Diamond-Dybvig Banking Model

This model illustrates bank runs.
There are three periods (0, 1, and 2) in the model.
There are early consumers (need money at t=1) and late consumers (need money at t=2).
Banks offer deposit contracts to balance the needs of early and late consumers.

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Description

This quiz explores key concepts in Macroeconomics II, focusing on money, monetary policy, banks, and their impact on the economy. It also revisits previously discussed real variables while introducing nominal variables such as inflation and nominal interest rates. Engage with essential questions about the relevance of money and the effects of expansionary monetary policy.