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Econ reading - Assignment Example

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Money is combination of assets that used as a medium of exchange in an economy while commodity money is the value that an item has even if it has not been utilized as money for example; a gold (Mankiw, 2011). …
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Download file to see previous pages... On the contrary, Fiat money is the one that does not have intrinsic value. Fiat money may be utilized upon government decree. On the other hand, demand deposits are account balances in a bank that depositors may obtain via writing a check upon request. Therefore, demand deposits should be included in the stock money in order to measure the value of money in the stock (Mankiw, 2011). The U.S Federal Reserve System acts as a central bank, it sets monetary policies in an economy. The Federal group is appointed by the president upon senate approval. Fed can increase the amount money in circulation through open market operation, whereby, Fed can make dollars and utilize them to buy bonds this led to an increase the amount of money in circulation (Mankiw, 2011). On the contrary, banks do not hold 100 reserves because they lend some money to earn profits. The relationship between amount of reserves and amount of money in the banking system a rises because banks accepts deposits from the public and lend out some deposits while ensuring proportion bank reserve is maintained (Mankiw, 2011). If bank A has a leverage ratio of 10, while Bank B has a leverage ratio of 20 whereby, similar losses on bank loans at the two banks cause the value of their assets to fall by 7 percent. The above statement indicates that bank B showed a larger change in bank capital than bank A because its capital value declined twice as much as bank A. However, the two banks remained solvent because they can be able to meet their financial obligation. Connectively, discount rate is an interest rate charged by Fed to commercial banks when advancing loans, when Fed raises discount rates, the amount of money in circulation decreases (Mankiw, 2011). Discount rate is the interest rate charged by Fed to commercial bank on borrowed funds, when Fed raises the discount rates, bank reserve decrease this in turn causes the cost of borrowing to increase. This discourages borrowing and consequently reduces the amount of money in circulation (Mankiw, 2011). . On the other hand, a reserve requirement is the amount of funds that a bank should retain after advancing loans. Whereby, an increase in reserve requirement causes an increase in reserve ratio, this in turn leads to a decrease in money supply. Additionally, Fed can not perfectly control the supply money because it does not have control of the amount of money held in the pockets of households. Secondly, Fed does not have control of the amount of money advanced as loans by the banks (Mankiw, 2011). 2.) Answer Questions for Review #1 in the middle of page 666 The value of money may be affected through increasing price level. This is because the money tends to lose its value this further reduces the purchasing power of money. According to the quantity theory of money, an increase in quantity of money leads to an increase in inflation rates. In above connection, nominal variables are those measured in monetary terms while real variables are those that can be measured in physical terms. According to the principle of monetary neutrality, nominal variables may be affected by changes in quantity of money. Inflation is like a tax in the senses that when government print money, the amount of money held by people losses value due to increase in money supply (Mankiw, 2011). According to Fishers effect, an increase in inflation rate causes real interest to fall. On the hand, nominal interest rate increases. The cost of inflation may involve menu cost that causes the company to adjust its prices such cost of printing new catalogues, advertising to mention just but a few. The most important cost for the U.S economy is inflation cost because an increase the tax burden ...Download file to see next pagesRead More
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