NAME: STEFAN SOOKOO

STUDENT NUMBER: 1002899562

PROFESSOR: ROBERT MCKEOWN
DATE SUBMITTED: MONDAY 26TH MARCH 2018
CLASS: ECO208Y1
Question 1:

Total M1 vs. Currency Component of M1

4000
3500
3000
Amount $

2500
2000
1500
1000
500
0
2/1/1984

8/1/1994
4/1/1985
6/1/1986
8/1/1987
10/1/1988
12/1/1989
2/1/1991
4/1/1992
6/1/1993

10/1/1995
12/1/1996
2/1/1998
4/1/1999
6/1/2000
8/1/2001
10/1/2002
12/1/2003
2/1/2005
4/1/2006
6/1/2007
8/1/2008
10/1/2009
12/1/2010
2/1/2012
4/1/2013
6/1/2014
8/1/2015
10/1/2016
12/1/2017
Year

M1 Money Stock Currency Component of M1

From the data above, we can see that M1 money stock is much higher than the currency

component of M1. There is a positive correlation between both trends. Therefore, as the currency

component increases, M1 money stock also increases. In addition, a substantial increase is

occurring after the financial crisis of 2009.

Question 2:

Excess Reserves Excess Reserves

3000000

2500000
Excess Reserves $

2000000

1500000

1000000

500000

1997-11-01

2000-05-01
1984-02-01
1985-05-01
1986-08-01
1987-11-01
1989-02-01
1990-05-01
1991-08-01
1992-11-01
1994-02-01
1995-05-01
1996-08-01

1999-02-01

2001-08-01
2002-11-01
2004-02-01
2005-05-01
2006-08-01
2007-11-01
2009-02-01
2010-05-01
2011-08-01
2012-11-01
2014-02-01
2015-05-01
2016-08-01
2017-11-01
Date

Excess reserves was lower than $500000 from February 1984 to February 2009. Post financial

crisis and the economy’s excess reserves have increased with a small decrease from 2014 to

2016. However, as of recent it is increasing once again. These large increases is caused by the

Central Bank introducing new forms of money to the money supply. The Central Bank simply

creates money in order to stimulate growth in the economy.

Question 3:

Total Monetary Base vs. Currency in Circulation

4500000
4000000
3500000
$ in millions

3000000
2500000
2000000
1500000
1000000
500000
0

1993-06-01

2013-04-01
1984-02-01
1985-04-01
1986-06-01
1987-08-01
1988-10-01
1989-12-01
1991-02-01
1992-04-01

1994-08-01
1995-10-01
1996-12-01
1998-02-01
1999-04-01
2000-06-01
2001-08-01
2002-10-01
2003-12-01
2005-02-01
2006-04-01
2007-06-01
2008-08-01
2009-10-01
2010-12-01
2012-02-01

2014-06-01
2015-08-01
2016-10-01
2017-12-01
Date

Total Monetary Base Currency in Circulation

Total Monetary Base and Currency in Circulation is relatively the same from February 1984 to

August 2008. However, with the introduction of many other means of storing money and the

switch to the use of direct deposits and ATMS, the Total Monetary Base has risen significantly

while Currency in Circulation has increased gradually.

Question 4:

Effective Federal Funds Rate vs. Interest Rate on Excess Reserves

1.60
1.40
1.20
1.00
Rates, %

0.80
0.60
0.40
0.20
0.00
2010-02-01

2017-02-01
2008-10-01
2009-02-01
2009-06-01
2009-10-01

2010-06-01
2010-10-01
2011-02-01
2011-06-01
2011-10-01
2012-02-01
2012-06-01
2012-10-01
2013-02-01
2013-06-01
2013-10-01
2014-02-01
2014-06-01
2014-10-01
2015-02-01
2015-06-01
2015-10-01
2016-02-01
2016-06-01
2016-10-01

2017-06-01
2017-10-01
Date

Effective Federal Funds Rate Interest Rate on Excess Reserves

From the data above, Effective Federal Funds Rate and the Interest Rate on Excess reserves has

been positively correlated. Interest rates on reserves are higher than the effective federal funds

rate throughout the time series but the data shows that they move positively together.
Question 5:

Consumer Price Index for all Urban Consumers: All Items

300.000

250.000

200.000
CPI %

150.000

100.000

50.000

0.000

2003-12-01

2013-04-01
1984-02-01
1985-04-01
1986-06-01
1987-08-01
1988-10-01
1989-12-01
1991-02-01
1992-04-01
1993-06-01
1994-08-01
1995-10-01
1996-12-01
1998-02-01
1999-04-01
2000-06-01
2001-08-01
2002-10-01

2005-02-01
2006-04-01
2007-06-01
2008-08-01
2009-10-01
2010-12-01
2012-02-01

2014-06-01
2015-08-01
2016-10-01
2017-12-01
Date

The consumer price index for all urban consumers for all items has positively increased

throughout the years. The time series shows that overtime, prices are increasing gradually within

the economy.

Question 6:

It is better to use the Total Monetary Base because it gives a true reflection of all the money in

circulation within the economy. Total Monetary Base includes M1 which is the total amount of

money in circulation. M1 only gives a reflection of notes and coins in circulation. However,

consumers may purchase goods and services using deposits or other means of payment without

the use of notes and coins. Therefore, using the total monetary base with the average price level

will give a truer reflection of the progression of the economy as an aggregate.

Question 7:

Total Interest Paid On Excess Reserves

3500000
3000000
Total Interest Paid, $

2500000
2000000
1500000
1000000
500000
0
2011-02-01

2013-06-01
2008-10-01
2009-02-01
2009-06-01
2009-10-01
2010-02-01
2010-06-01
2010-10-01

2011-06-01
2011-10-01
2012-02-01
2012-06-01
2012-10-01
2013-02-01

2013-10-01
2014-02-01
2014-06-01
2014-10-01
2015-02-01
2015-06-01
2015-10-01
2016-02-01
2016-06-01
2016-10-01
2017-02-01
2017-06-01
2017-10-01
Date

Total interest paid on excess reserves increases positively with a minor decrease in the year

2015. However, it continues to increase significantly as the US pays more to excess reserves

every year.

Question 8:

From the data previously calculated, the amount of interest the US has paid to private banks and

financial institutions during the year 2017 is $31312.74 billion dollars. If the US Government did

not have to pay this amount, the remittance for the US treasury would be $31392.94 billion

dollars. This is a substantial amount more than the original remittance the US treasury had in the

year 2017.
 With a booming economy, the United States government must be prepared to ensure the

country does not overheat economically. Federal Reserve Chairman Jerome Powell argues for a

gradual increase in interest rates to mediate the situation (Reuters, 2018). His goal is to maximize

employment while keeping prices stable. Since recent tax cuts have been implemented, the

economy is flourishing with demand which leads to price increases. Powell’s policy to gradually

increase interest rates is best suited for achieving their goal of maximum employment and stable

prices because the New Keynesian model implies ‘sticky’ prices and wages will keep the

economy balanced.

Using the New Keynesian model we know that prices do not react to changes in policies

in the short run (Williamson, 2015). Therefore, when the economy incrementally increases their

interest rates, the Government will use monetary policy to ensure the inflation in the economy is

controlled and reaches its goal of 2%. This increase will lead to consumers saving more of their

income in order to account for future expenditure, avoiding serious demand-pull inflation. Since

the interest rates are growing over time, we know that demand will not fall significantly therefore

some inflation still occurs, which will get the Government to their target rate of inflation.

Powell argues that wages may also increase in the future as recent productivity gains and

increases in investment spending will aid the increase (Bloomberg, 2018). Many people may

think that an increase in the interest rate will decrease wages but wages are also sticky in the

short run (Williamson, 2015). In addition, minimum wage legislature will prevent wages from

falling drastically. In our Keynesian model, since the interest rate increases but investment

spending also increases, the economy experiences positive economic growth. Since the economy

is booming, producers need to increase output which will require additional labour. The increase

in the interest rate boosts the labour supply in the economy while labour demand also rises. This
indicates that employment will increase and wages will also increase in the economy which

ultimately satisfies Powell’s goals for the US.

The Government must strike the perfect balance of interest rate proliferation. If the

Government spikes interest rates then they run the risk of a recession. However, with the recent

tax cuts implemented, the Government must ensure that the interest rate increases gradually in

order to prevent the labour market from overheating (Yellen, 2017). Therefore, with a gradual

increase in the interest rate, employment will also increase gradually and not overheat. If the

Government spikes interest rates then many firms will realise a reduction in demand for their

goods which will lead to them decreasing their demand for labour. This will inevitably lead to

unemployment rising and a recession occurring. Therefore, there is a thin line between price

stabilisation and an economic downturn. Thus, the Government must find an increase in interest

rates that will not offset the economic growth significantly.

This policy has many concerns that may hinder its success such as consumers being

unduly exuberant in recent times, asset markets ability to deal with interest rate growth and

corporate debt. In December, the personal saving rate was 2.4%, the lowest it has been in over a

decade (Economist, 2018). This means that consumers are spending high amounts of their

income recently. Therefore a gradual increase in interest rates may not fully affect consumers

and they may continue to spend a majority of their income. This leads to an inevitable increase in

inflation that could become worrisome. Secondly, if asset markets are not ready for this policy

then the market could fall significantly, developing a recession that will be similar to 2009.

Lastly, if interest rates rise then companies with corporate debt have to pay a higher interest on

this debt which may result in liquidity. Corporate firms going into liquidity results in citizens

becoming unemployed and overall production in the economy to dwindle.

 Overall, Powell’s policy is a strategically excellent plan in order to maximise

employment and stabilize prices given that it is done in an efficient manner. The use of monetary

and fiscal policy to aid in this decision is critical. The perfect balance between Central Bank

policy adjustments and Government intervention is key. In a booming economy it is very

difficult to implement minor contractionary fiscal and monetary policy but it must be done to

prevent the economy from overheating. Once Powell and the US Government has accounted for

the aforementioned setbacks that this policy may encounter success will occur.

(746 words)

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