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ECON 100 Tutorial 22

ECON 100 Tutorial 22. Rob Pryce www.robpryce.co.uk/teaching. Question 1. What is broad money?.

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ECON 100 Tutorial 22

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  1. ECON 100Tutorial 22 Rob Pryce www.robpryce.co.uk/teaching

  2. Question 1 What is broad money? Broad money is a measure of the money supply that includes more than just physical money such as currency and coins (also termed narrow money). It generally includes demand deposits at commercial banks, and any monies held in easily accessible accounts. Components of broad money are still very liquid, and non-cash components can usually be converted into cash very easily. (wikipedia) Normally labelled M3.

  3. Question 1 If the commercial banking sector holds 18% reserve assets (cash ≡ narrow money); if the general public holds cash to bank deposits in the ratio 1:8; and if the volume of narrow money (cash) is 100 units, what is the volume of broad money (that is, cash and bank deposits held by the general public) in circulation? We know 3 equations from this question: Reserve Ratio = RR = = 0.18 Currency Drain Ration = CDR = = 0.125 Narrow Money = C = CB + CP = 100 The answer is calculated from re-arranging these 3 equations and also knowledge that Broad Money = M = BD + CP

  4. Question 1 If the commercial banking sector holds 18% reserve assets (cash ≡ narrow money); if the general public holds cash to bank deposits in the ratio 1:8; and if the volume of narrow money (cash) is 100 units, what is the volume of broad money (that is, cash and bank deposits held by the general public) in circulation? + = 0.18 + 0.125 = 0.305 + = = = 0.305 C = 100, so = 0.305 → BD = =327.87 CP = 0.125 x BD = 40.98 M = BD + CP = 327.87 + 40.98 = 368.85

  5. Money Multiplier FORMULA: where and Or more simply, which should be easier to remember for the class test What happens when we change the RR and CDR?

  6. Money Multiplier RR = 0.1 CDR = 0.05 Started with £1000, now there is £7000, multiplier = 7

  7. Money Multiplier RR = 0.2 CDR = 0.05 Started with £1000, now there is £4200, multiplier = 4.2

  8. Money Multiplier RR = 0.2 CDR = 0.1 Started with £1000, now there is £3666, multiplier = 3.666

  9. Question 2 Explain why the whole amount of narrow money is not included in the total amount of broad money. M = CP + BD Why not include CB? This would be double counting, since BD = CB + BB + PBB (taken from lecture 59) So we can write M = CP + CB + BB+ PBB, but not M = CP + BD + CB

  10. Question 3 From the national income identity, what association might exist between a fiscal deficit and a trade deficit? Y = C + I + G + X – M please get bored of writing this! Y – T = Yd Y = Yd + T = C + I + G + X – M Yd = C + I + G – T + X – M if Yd = C + S where S is savings Yd – C = S = I + G - T + X – M re-arrange to get (S – I) = (G – T) + (X – M)

  11. Question 3 (S – I) = (G – T) + (X – M) now if S = I (G – T) + (X – M) = 0 (G – T) = -(X – M) (G – T) = (M – X) So if G > T, M > X If there is a fiscal deficit, there must be a trade deficit Only if S = I

  12. Question 4 Gerry’s answer: “The monetary theory of international payments adjustment provides an explanation. When a state pursues a profligate monetary policy, the exchange value of its sovereign currency tends to fall. Governments take a monopolist’s profit (seigniorage) from the use of its sovereign currency, the demand for which is negatively correlated with the stability of its value.”

  13. Question 5

  14. Question 5

  15. Question 6 Is the balance of international payments an accountancy principle or an economic concept? Or is it both? Gerry says: “It is an accountancy principle whereby categories of international financial flows are defined such that international payments are necessarily ‘balanced’. The structure of that balance is a matter for interpretation. The economic issue is whether payments flows are sustainable; e.g., for how long will China accumulate US Bonds? (China held $1.1 trillion in Dec 2011.)”

  16. Question 7 Without trade statistics, how might an international payments problem be noticed? Through exchange rates. Since BoP = 0: X = M, or X + “debt we owe” = M + “debt we are owed” The USA mostly has “debt we owe”, China mostly has “debt we are owed” An international payments problem would mean that debt would not be accepted as payment. If China stops accepting US debt as payment, the exchange rate falls and the dollar loses value.

  17. Question 7 The USA mostly has “debt we owe”, China mostly has “debt we are owed”. An international payments problem would mean that debt would not be accepted as payment. If China stops accepting US debt as payment, the exchange rate falls and the dollar loses value. You should note that if the dollar loses value, Chinese imports become more expensive for US consumers and the demand for Chinese imports falls. China has an interest in keeping the value of the US dollar high relative to the Chinese yuanif it wants to export to the US. China has been accused of keeping the value of the yuan artificially low.

  18. Any Questions? Email: r.pryce@lancaster.ac.uk Web: www.robpryce.co.uk/teaching OfficeHour: Wednesday, 9:45 – 10:45 Charles Carter C Floor or by appointment (email me)

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