Chapter 16: Q.a For Critical Thinking (page 352)
Why do you suppose that corporate cash holdings have decreased slightly since 2015?
Corporate cash holdings have decreased slightly due to transaction cost motive, precautionary demand motive, agency cost motive, taxation motive
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On the basis of Problem 16-1, imagine that initially the market interest rate is 5 per cent and at this interest rate you have decided to hold half of your financial wealth like bonds and half as holdings of non-interest-bearing money. You notice that the market interest rate is starting to rise, however, and you become convinced that it will ultimately rise to 10 per cent.
a. In what direction do you expect the value of your bond holdings to go when the interest rate rises?
b. If you wish to prevent the value of your financial wealth from declining in the future, how should you adjust the way you split your wealth between bonds and money? What does this imply about the demand for money?
Suppose that, initially, the U.S. economy was in an aggregate demand-aggregate supply equilibrium at point A along with the aggregate demand curve AD in the diagram below. Now, however, the value of the U.S. dollar suddenly appreciates relative to foreign currencies. This appreciation happens to have no measurable effects on either the short-run or the long-run aggregate supply curve in the United States. It does, however, influence U.S. aggregate demand.
a. Explain in your own words how the dollar appreciation will affect net export expenditures in the United States.
b. Of the alternative aggregate demand curves depicted in the figure- versus which could represent the aggregate demand effect of the U.S. dollar's appreciation? What effects does the appreciation have on real GDP and the price level?
c. What policy action might the Federal Reserve take to prevent the dollar's appreciation from affecting equilibrium real GDP in the short run?
Consider figure 16-7. Discuss a specific monetary policy action that Fed's Trading Desk could implement in order to induce the effects traced out by this figure.
Assume that the following conditions exist :
a. All banks are fully loaned up - there are no excess reserves, and desired excess reserves are always zero.
b. The money multiplier is .
c. The planned investment schedule is such that at a percent rate of interest, the investment is billion; at 5 percent, investment is billion
d. The investment multiplier is .
e. The initial equilibrium level of real GDP is trillion.
f. The equilibrium rate of interest is percent.
Now the Fed engages in expansionary monetary policy. It buys billion worth of bonds, which increases the money supply, which in turn lowers the market rate of interest by percentage point. Determine how much money supply must have increased, and then trace out the numerical consequences of the associated reduction in interest rates on all the other variables mentioned.
Assume that the following conditions exist :
a. All banks are fully loaned up - there are no excess reserves, and desired excess reserves are always zero.
b. The money multiplier is .
c. The planned investment schedule is such that at a percent rate of interest, investment is billion. At percent, investment is billion.
d. The investment multiplier is .
e. The initial equilibrium level of real GDP is trillion.
f. The equilibrium rate of interest is percent.
Now the Fed engages in contractionary monetary policy. It sells billion worth of bonds, which reduces the money supply, which in turn raises the market rate of interest by 1 percentage point. Determine how much the money supply must have decreased, and then trace out numerical consequences of the associated increase in interest rates on all other variables mentioned.
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