AP_Krugman_Textbook

292 section 5 The Financial Sector

14.Although the U.S. Federal Reserve doesn’t use changes in re-
serve requirements to manage the money supply, the central
bank of Albernia does. The commercial banks of Albernia
have $100 million in reserves and $1,000 million in checkable
deposits; the initial required reserve ratio is 10%. The commer-
cial banks follow a policy of holding no excess reserves. The
public holds no currency, only checkable deposits in the bank-
ing system.
a.How will the money supply change if the required reserve
ratio falls to 5%?
b.How will the money supply change if the required reserve
ratio rises to 25%?

15.Using Figure 26.1 find the Federal Reserve district in which
you live. Go to http://www.federalreserve.gov/bios/pres.
htm, and click on your district to identify the president
of the Federal Reserve Bank in your district. Go to
http://www.federalreserve.gov/fomc/ and determine if the
president of the Fed is currently a voting member of the Fed-
eral Open Market Committee (FOMC).

16.The Congressional Research Service estimates that at least $45
million of counterfeit U.S. $100 notes produced by the North
Korean government are in circulation.
a.Why do U.S. taxpayers lose because of North Korea’s
counterfeiting?
b.As of September 2008, the interest rate earned on one-
year U.S. Treasury bills was 2.2%. At a 2.2% rate of inter-
est, what is the amount of money U.S. taxpayers are
losing per year because of these $45 million in
counterfeit notes?

17.The accompanying figure shows new U.S. housing starts, in
thousands of units per month, between January 1980 and Sep-
tember 2008. The graph shows a large drop in new housing
starts in 1984–1991 and 2006–2008. New housing starts are re-
lated to the availability of mortgages.

a.What caused the drop in new housing starts in 1984–1991?

b.What caused the drop in new housing starts in 2006–2008?

c.How could better regulation of financial institutions have

prevented these two occurrences?

2,400

2,200

2,000

1,800

1,600

1,400

1,200

1,000

800

New housing

starts

(thousands)

Year

1980 1985 1990 1995 2000 20052008

Source: Federal Reserve Bank of St. Louis.

18.Use the market for loanable funds shown in the accompany-

ing diagram to explain what happens to private savings, pri-

vate investment spending, and the rate of interest if the

following events occur. Assume that there are no capital in-

flows or outflows.

a.The government reduces the size of its deficit to zero.

b.At any given interest rate, consumers decide to save more.

Assume the budget balance is zero.

c.At any given interest rate, businesses become very optimistic

about the future profitability of investment spending. As-

sume the budget balance is zero.

19.The government is running a budget balance of zero when it

decides to increase education spending by $200 billion and

finance the spending by selling bonds. The accompanying dia-

gram shows the market for loanable funds before the govern-

ment sells the bonds. Assume that there are no capital inflows

or outflows. How will the equilibrium interest rate and the

equilibrium quantity of loanable funds change? Is there any

crowding out in the market?

20.In 2006, Congress estimated that the cost of the Iraq War was

approximately $100 billion a year. Since the U.S. government

was running a budget deficit at the time, assume that the war

was financed by government borrowing, which increases the

demand for loanable funds without affecting supply. This

question considers the likely effect of this government expen-

diture on the interest rate.

a.Draw typical demand (D 1 ) and supply (S 1 ) curves for

loanable funds without the cost of the war accounted

for. Label the vertical axis “Interest rate” and the

horizontal axis “Quantity of loanable funds.” Label

D

E

Interest S

rate

r 1

Q 1 Quantity of loanable funds

0 $200 400 600 800 1,000 1,200

24%

22

20

18

16

14

12

10

8

6

4

2

Interest

rate

Quantity of loanable funds (billions of dollars)

D

E

S