Econ 304 Spring 2013Problem Set #2 Due by 11:59 PM MST February 15Please ensure you show all work on your answers.
1.
(5 points each part)To increase tax revenue, the U.S. government imposed a 2-cent tax on checks written on bank account deposits.
a.
How do you think the check tax affected the currency-deposit ratio?
b.
Use the model of the money supply under fractional reserve banking to discuss how this tax affected the money supply.
c.
Many economists believe that a falling money supply was in part responsible for the severity of the Great Depression of the 1930's. From this perspective, was the check tax a good policy to implement in the middle of the Great Depression? Why or why not.
2.
(6 points each part)An economy has a monetary base 1,000 $1 bills. Calculate the money supply in scenarios (a)-(d) and then answer part e.
a.
All money is held as currency
b.
All money is held as demand deposits. Banks hold 100% of deposits as reserves
c.
All money is held as demand deposits. Banks hold 20% of deposits as reserves
d.
People hold equal amounts of currency and demand deposits. Banks hold 20% of deposits as reserves.
e.
The central bank decides to increase the money supply by 10%. In each of the above four scenarios, how much should it increase the monetary base?
3.
(5 points each part)A newspaper article once reported that the U.S. economy was experiencing a low rate of inflation. It said that "low inflation has a downside: 45 million recipients of Social Security and other benefits will see their checks go up by just 2.8% next year."
a.
Why does inflation affect the increase in Social Security and other benefits?
b.
Is this effect a cost of inflation, as the article suggests? Why or why not.
4.
(5 points each part)Suppose a country has a money demand function (M/P)
d=kY, where k is a constant parameter. The money supply grows by 12% per year, and real income grows by 4%.
a.
What is the average inflation rate?
b.
How would inflation be different if real income growth were higher? Explain.
c.
How do you interpret the parameter k? What is its relationship to the velocity of money?
d.
Suppose, instead of a constant money demand function, the velocity of money in this economy was growing steadily because of financial innovation. How would that affect the inflation rate? Explain.