UGBS204:

MACROECONOMICS AND BUSINESS

2ND SEMESTER 2021/2022
SOLUTIONS TO TUTORIAL SET 4.
Compiled by: Gabriel Nartey (0555295278)

PROBLEM ONE
In ordinary language, clearly distinguish between the following pairs of concepts.
a. Fiscal and Monetary Policy
Fiscal Policy refers to the use of government spending or taxes to affect economic activity.
Monetary Policy on the other hand refers to the process in which the central bank increases or
decreases the money supply in order to influence the level of economic activity and or/ stabilize
prices.
b. Expansionary Monetary Policy and Contractionary Monetary Policy
Expansionary monetary policy is a policy where the central Bank increases the money supply in
the economy. Whilst contractionary monetary policy is a policy where the central bank reduces
the supply.
c. Expansionary Fiscal Policy and Contractionary Fiscal Policy.
Expansionary fiscal policy refers to the increase in government spending or decrease in taxes to
stimulate the level of economic activities whilst contractionary fiscal policy refers to the
decrease in government spending or increase in taxes to decrease the level of economic
activities.
d. Primary budget deficit and overall budget deficit
Primary budget deficit is the difference between current government spending on goods and
services and total current revenue from all types of taxes net of transfer payments. Primary
deficit can be gotten by deducting interest payment from fiscal deficit/total revenue-total
expenditure excluding interest payment. While overall budget deficit is the excess total
government expenditure over total government receipts. Overall budget can be arrived at by
summing primary deficit plus interest payments on borrowings.
e. Official reserves assets and Official settlement balance
Official reserve assets refers to assets such as gold, foreign bank deposit and special asset
account created by the IMF that are held by central banks, that can be used in making

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Official reserves are assests such as foreign deposite created by IMF that are held by the central
bank that can be used in making international payment.
 Primary deficit refers to the difference between the current year's fiscal deficit and interest payment
on previous borrowings

international payments. Official settlement balance on the other hand refers to the net increase
in a country’s official reserve assets. It is used to keep track of the Central Bank' reserves.
f. Capital market and financial intermediaries
Capital markets are markets that trade in financial instruments such as bonds, stocks and
currency, while financial intermediaries are institutions that provide financial services and
products.
g. Narrow money and broad money
Narrow money is the most liquid form of money, it generally consist of paper currency(notes),
coins, and demand deposits held by banks. Broad money is less liquid but the most inclusive form
of money and it is made up of narrow money in addition to saving accounts and time deposit
accounts.
g. Money supply multiplier and autonomous expenditure multiplier.
Money supplier multiplier is a multiple by which money supply changes if there is a change in
bank deposits. Whilst autonomous expenditure multiplier is a multiple by which equilibrium
income changes if there is a change in any autonomous components, except taxes.

PROBLEM TWO
All else being equal, how would each of the following affect the demand for M1? The
demand for M2? Explain.
• Narrow money or M1 which consists of Paper currency and coins with the public
Demand deposits (checking) accounts. M1 money supply includes coins and currency in
circulation
• M2 include m1, Savings accounts, Time deposit accounts. In Ghana, there is also M2+
which is M2 plus foreign currency deposits

a) Home equity lines of credit that allow home owners to write checks against the value
of their homes are introduced.
This will reduce the demand for M1 and M2. Being able to write checks against home means that
owning homes now offers almost the same level of convenience that holding M2 offers in terms of
transactions. Since home values increases very rapidly, with the added convenience transactions,
we should expect households to hold more of their wealth in homes compared with M2 and M1.
b) The stock market crashes, and further sharp declines in the market are widely
feared.

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This will increase the demand for M1 since there turn (and expected) return on other financial
assets are lower. The opportunity cost of holding M1 has fallen so there will be an increase in
demand. By a similar reasoning, the demand for M2 will also increase. Demand for money will
rise and expected return on stocks will reduce.
c)Banks introduce overdraft protection, under which funds are automatically transferred
from savings to checking as needed to cover checks. Overdraft protection kicks in when a
customer writes a cheque for more than the amount in their account.
This will reduce the demand for M1. With this in novation, households do not need to hold as
much M1 for purchases as the can easily move money from savings account. Therefore, they
will hold more of their wealth from cash and checking accounts to their savings accounts
incase savings accounts generally offers a higher interest rate. Therefore, M2 remains
unchanged but M1 decreases.
d)A crack down reduces the illegal drug trade (which is carried out largely in currency).
This is likely to reduce M1 and M2 because it is likely to reduce cash holdings (illegal drug
traders mostly transact business in cash).

e)What are the impact of these transactions on M1 and M2

i. Suppose Tabatha takes $500 from her savings account and deposits it in her
checking account.
M1 increases and M2 remains unchanged

ii. You move some money from checking account into your savings account
M1 decreases and M2 remains unchanged

(h)Explain three roles of financial systems

• Mobilizing and allocating resources
• Managing risks within an economy
• Acting as clearing houses
• Transfering resources across space and time

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 PROBLEM THREE
For problem three, refer to the Bank of Ghana’s Monetary Policy Committee Press Release of
March 2020.
a) In ordinary language, explain the meaning of monetary policy. Differentiate
between contractionary and expansionary monetary policy.
Monetary policy is a policy used by the central bank to increase or decrease the money supply in
the economy in order to influence economic activities.
Monetary loosening, also referred to as expansionary monetary policy, means the central bank is
increasing the money supply while monetary tightening (contractionary monetary policy) means
the central bank is reducing the money supply.
b) According to the statement, the MPC decreased the monetary policy rate (MPR)
from 16 to 14.5%. Does this constitute a contractionary or an expansionary
monetary policy? Explain.
This constitutes an expansionary monetary policy because by decreasing the policy rate, the
central bank is trying to increase the money supply
c) What was the overriding concern of the Committee that led to the decrease?
The Committee was concerned about declining rate economic growth as projected due to
impact of COVID19 on the global economy and along with sharp falls in prices. The
committee was concerned about stabilizing financial markets. For instance, it noted in point 6
that “the negative impact of COVID-19 on exports, imports, taxes, and foreign exchange
receipts will culminate in a slowdown in economic activity.”

d) Using money market, explain the effect of this decrease in the MPR on the real
interest rate.

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The decrease in the policy rate represents as increase in the nominal money supply. Given the
price level, this increases the real money supply, shifting the money supply curve to the right.
Real money balances increases at the new equilibrium while interest rate falls.
e) Explain how the change in real interest rate identified in part (d) will affect desired
consumption and investment spending. (2marks)
Following from part (d) above, the decrease in the interest rate will increase desired
consumption because the lower interest rate decreases the opportunity cost of consuming
today. Also, the lower interest rate decreases the cost of and investment and increases
investment spending.
f) Explain how the decrease in MPR will help address the overriding concern of the
Committee identified in part (b) above. (2marks)
Following from part (e) above, the increase in consumption and investment spending will
increase Aggregate Demand, and as we learning in the simple Keynesian system, this will boost
economic growth.

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 PROBLEM FOUR

a. Given a required reserve ratio of 20 percent, what is the maximum deposit that can
be created by commercial banks from an initial deposit of 30,000 Ghana cedis?
Explain why this maximum deposit may not be achieved in reality.
1
Max Deposit = 𝑅𝑅 × 𝐼

Where RR is the required reserve ratio and I is the initial deposit

1
Max Deposit =0.2 × 30,000

= 150,000
This maximum deposit will not be achieved in reality because not all the initial will
go through the banking system.

b. If Commercial Banks receive a total of ₵100 min deposits with a 10% required
reserves out of total deposits.

(i)Find the value of the money multiplier?

1
Money Multiplier = 𝑅𝑅
1
=0.1
=10

(ii.) What is the amount of money in circulation as a result of the total

deposit?
1
Max Deposit=𝑅𝑅 × 𝐼
1
=0.1 × 100

=1000

(iii.) If the central bank now raises required reserve to 20% of deposits,
what is the value of money multiplier.
1
Money Multiplier =𝑅𝑅
1
=0.2
=5

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 (iv)What is the amount in circulation as a result of the new required
reserve rate?
1
Max Deposit=𝑅𝑅 × 𝐼
1
=0.2 × 100

=500
a. You take ₵200 you have kept under your pillow and deposit it in your bank
account. If the required reserves is 5% of total deposits, Find the change in money
supply as a result of your deposit.

1
∆Money Supply=𝑅𝑅 × ∆𝐷

Where ∆D is change in deposit

1
∆Money Supply=0.05 × 200

=4000

b. Name four financial intermediaries

• Banks
• Insurance companies
• Pension funds
• Stock Exchange

e. Mention three tools used by the central bank to conduct monetary policy
• Open Market Operations (OMO)
• Reserve requirement policy
• Discount rate Policy
f. Identify and explain two motives for holding money. Explain two determinants of each
motive identified.
Three motives of holding money; Transactional, precautionary and
speculative(asset)motives.

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 ▪ Transactional motive:
money the held for day-to-day activities; or money held for daily
transactions such as purchasing of good and services. It depends on a
number of factors including the income of the individual, the number of
transactions, payment system (i.e.Whether individuals are paid monthly or
weekly), interest rate and price level.
▪ Precautionary motive:
money held for unforeseen circumstances. It depends on the income of the
individual, interest rate, payment system (i.e.Whether individuals are paid
monthly or weekly)
▪ Speculative motive:
money held for speculative purposes or money held to buy bonds when
bond prices are low. It depends on the interest rate and bond prices

THE END.
THANK YOU.
Be diligent.

“Every good and perfect gift comes from above…”.

James 1:17

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