Chapter 6 Money and Banking

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Tutorial Answers: Chapter 5

2.(a) More, because your wealth has increased; (b) more, because the house has become more liquid; (c) less, because its expected return has fallen relative to Microsoft stock; (d) more, because it has become less risky relative to stocks; (e) less, because its expected return has fallen.

7.In the loanable funds framework, when the economy booms, the demand for bonds increases. The public’s income and wealth rises while the supply of bonds also increases, because firms have more attractive investment opportunities. Both the supply and demand curves (Bd and Bs) shift to the right, but as is indicated in the text, the demand curve probably shifts less than the supply curve so the equilibrium interest rate rises. Similarly, when the economy enters a recession, both the supply and demand curves shift to the left, but the demand curve shifts less than the supply curve so that the interest rate falls. The conclusion is that interest rates rise during booms and fall during recessions: that is, interest rates are procyclical. The same answer is found with the liquidity preference framework. When the economy booms, the demand for money increases; people need more money to carry out an increased amount of transactions and also because their wealth has risen. The demand curve, Md, thus shifts to the right, raising the equilibrium interest rate. When the economy enters a recession, the demand for money falls and the demand curve shifts to the left, lowering the equilibrium interest rate. Again, interest rates are seen to be procyclical.

Tutorial Answers: Chapter 6

5.The rise in the value of stocks would increase people’s wealth and therefore the demand for Rembrandts would rise.

6.When the Fed sells bonds to the public, it increases the supply of bonds, thus shifting the supply curve Bs to the right. The result is that the intersection of the supply and demand curves Bs and Bd occurs at a lower price and a...
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