Question

Suppose the reserve requirement is 0.20 and the marginal propensity to consume is 0.92.

a.        Calculate the money multiplier.

b.        Calculate the Keynesian income multiplier.

c.        Suppose the coronavirus pandemic has caused a crash in stock prices and has also negatively affected business confidence.

(1)        What components of expenditures are affected by the change in confidence, and in what direction?

(2)      Suppose the expenditures in (1) are affected by $200 billion. Using the Keynesian income multiplier calculated in (b), what is the expected ultimate impact on the national income?

d.        What would the Fed do with the discount rate and with the reserve requirement if it wanted to use monetary policy to deal with the problem in (c)? Explain how the money supply is affected by these actions.

e.         Suppose the Fed engaged in $16 billion in open market operations to deal with the problem in (c). What would it do? Using the money multiplier calculated in (a), how would the money supply ultimately be affected by this action?

f.         What impact would the action in (e) have on interest rates and how would that help in this situation?

g.        What problems might prevent this action by the Fed from being effective?

h.        Suppose the federal government decides to use fiscal policy to deal with the problem in (c ).

            (1)        What would it do?

(2)      How would rational expectations and crowding out limit the effectiveness of this action?

Answer 1