Macroeconomic Calculations - M1 and M2 - Essay Example

SECTION ONE: a) M1 is a sum of currency held by individuals and businesses, traveler’s checks and checkable deposits at banks and other s. Nov 2010 = $391.7 Billion Nov 2011 = $410.8 Billion b) Percentage Change = Percentage Change in Money Supply = (410.8 – 391.7)/391.7 * 100 = 4.87% c) Non-M1 M2: Nov 2010 = $6933.4 bn Nov 2011 = $7437.7 bn Total Saving Deposits: Nov 2010 = 5275.5 Nov 2011 = 5982.9 Total Small Denomination Time Deposits: Nov 2010 = 948.5 Nov 2011 = 768.7 Retail Money Funds: Nov 2010 = 709.5 Nov 2011 = 686.1 d) Nov 2010 = $391.7 + $6933.4 = $7325.1 bn Nov 2011 = $410.8 + $7437.7 = $7848.5 e) 7848.5 – 7325.1/ 7325.1 * 100 = 7.14% f) The difference between the growth rates of these two money bases is around 3%. M1 grew by 4.87%, whereas M2 grew by 7.14%. The difference between the growth rates of M2 from M1 can be explained by the fact that M1 is part of M2. So any change in M1 will be reflected in the changes in M2. Hence, the 4.87% change of M1 is instilled in the 7.14% change figure of M2. M1 changed because of the changes in currency floating in the economy and also because of increase in demand deposits. Traveler’s checks amount go down, but since currency and demand deposit account increased by larger proportion, the reduction in traveler’s checks had no impact on the overall M1. Checkable deposits in banks reduced in the period, but checkable deposits in thrift institutions increased. Hence, there was an increase in overall M1 level between the periods of one year from Nov 2010 to Nov 2011. In terms of M2, only M1 and saving deposits showed an increased. There was a fall in retail funds and small denomination of time deposits. But the increase in M1 and saving deposits was higher than the decrease in other components and hence M2 showed an increase over a period of one year from November 2010 to November 2011. SECTION 2: a) There won’t be any change to M1 since both the currency in circulation and checking account are part of M1. Hence shifting money from one head to another won’t have any impact on the total size of M1 and it will remain unchanged. b) There won’t be any change to M1 since the money is simply being transferred from one head of the M1 to another. Since M1 is part of M2 and there isn’t any change to M1, therefore M1 and M2 both will remain unchanged. c) There won’t be any change to M2. Since the money has been transferred to M1 base, but since M1 is part of M2, there won’t be any change to M2. However, M1 will rise by the amount of purchases since the money has been converted from saving account to money and notes in circulation. d) When Fed buys Treasury bills from the banks its liabilities and assets accounts both are being reduced. Since Treasury Bills represents the money that the Fed owes to commercial banks, therefore the reduction in Treasury Bills or purchase of Treasury Bills by the Fed is going to reduce the bank’s liability. At the same time, the Fed will have to pay cash to commercials banks as a settlement for purchase of Treasury Bills and therefore there will be a reduction in Fed’s assets as well. Therefore both the assets and liabilities sides of the balance sheet will get affected from the decision by Fed to repurchase the Treasury Bills from the open market of commercial banks. e) Any increase in the money supply when there is no increase in velocity and the national output is going to put inflationary pressure on the price level of an economy. In other words, any such increase that is not backed by increase in velocity or the national output or GDP is going to create inflation in the economy. d) The theory is represented by the following formula: M x V = P x O M represents money supply V represents velocity of money P represents price level in the economy O represents national output or GDP Suppose that at current level, the economy is in equilibrium where both sides can represent as 1 numerically. 1 x 1 = 1 x 1 Now, Fed increases the money supply from 1 to 10, whereas velocity and GDP remains constant. 10 x 1 = P x 1 P = 10 The equation tells us that the 10% increase in the money supply is going to create inflation of 10%. SECTION 3: a) The demand for dollar if plotted against the price has a negative or inverse relationship. The relationship can be justified by using two assumptions. First assumption is that the price level of dollar represents the exchange rate of dollar. The second assumption is that price level represents the interest rate. Ideally people would demand higher quantity of dollars when its exchange rate is cheaper, and since interest represents the cost of borrowing, people will demand high amount of dollars when interest rates are low. b) The current exchange rate of USD/Yen is Y81.36. This means that every $1 fetches 81.36 yen. This means that US currency is stronger than Japanese Yen. The export effect of this is that US citizen and businesses will find Japanese imports cheaper and Japanese citizen and business will find American imports as expense. This will give a boost to Japanese products in the international market and Japan would be able to export more to US than US companies will be able to sell in Japan. If the USD/Yen exchange rate declines to Y79, this will mean that Yen has gained some points against dollars. This will make Japanese exports expensive to American citizen even if the prices in Yen have not changed. Similarly, any rise in USD/Yen exchange to Y84 will mean that USD has increased in value and Japanese products would now be cheaper to American citizen and there is a change that Japanese exports to US may increase. c) The profit effect represent the profit earned by exporters as a result of fluctuations in exchange rates. Whenever the exchange rates of USD rise or USD becomes expensive, the profit margin for Japanese exporters increases even if they keep the same prices in Japanese Yen. This is because of the fact that each dollar would yield higher number of Yen and therefore exporters would earn more money from exporting to USA. Similarly, whenever the USD loses its value against Yen, the profit margin for Japanese exporters diminishes as each Dollar yield less Yen than before. d) The supply is upward sloping because the households and business wants to place their funds at higher interest rate in the market and at banks. Similarly, the supply curve is upward sloping because higher exchange rate means that the supplier of money can earn more from lending or selling the money than holding the money. e) Increase in USD exchange rate would mean that it will buy more of other currency and people holding dollar can benefit from it or become richer in terms of other currency. f) Profits increase when USD rise and people tend to supply more money to make more profit from the dollars they are holding and as a result the supply of dollar goes up. Read More