Question

1. The money supply in Econland is 4,500, and currency held by the public equals bank reserves. The desired reserve-deposit ratio is 0.20. Bank reserves equal ________.

2. "The European Central Bank should increase interest rates in order to keep inflation at an acceptably low level" is a ________ statement about ________ policy.

3. Suppose actual output equals $30 billion and potential output equals $20 billion, then this economy's output gap should be expressed as:

4. One year before maturity, the price of a bond with a principal amount of $1,000 and a coupon rate of 5 percent paid annually fell to $990. The one-year interest rate must be:

Answer 1

1. Money supply = currency held by the public + deposits

Or, 4500 = bank reserves + deposits

Or, bank reserves = deposits - 4500

Deposits = bank reserves / desired reserve - deposit ratio

Or, Bank reserves = deposits * 0.20

Therefore,

0.20 * deposits = Deposits - 4500

Or, 0.80 * Deposits = 4500

Or, Deposits = (4500 / 0.80) = 5625

Therefore, Bank reserves = 1125

2. A normative statement is a value judgement or opinion based statement, which can't be tested true or false and others may disagree with the statement.

The given statement is a normative statement about monetary policy.

3. Output gap = actual output - potential output = $30 billions - $20 billions = $10 billion.

As actual output exceeds potential output, therefore it's an inflationary gap.