Faculty of Finance and Banking

Bucharest University of Economic Studies

Money and Banking Tutorial 1, 1st year
1. Money
1. Monetary aggregates
M
M
M
m1= 1 ; m2 = 2 ; m3= 3
M0
M0
M0
c=

C
ER
MR
; e=
;r =
M
D MR D

cash preference

total cash

C
M
e

cash from total money

excess reserves from total deposits ratio

r MR=

MR
D

minimum reserve ratio from total deposits ratio (MR = minimum reserves).

Total deposits from the economy, based on the multiplication process:

D
r MR + cr MR c
2. Money multiplier:
1
m=
r MR + cr MR c
3. Money multiplier with excess reserves:
r
r
( RMO+e)+n( RMO+ e) n

1
m=
4. Money multiplier based on monetary aggregates:
C
D
1c =
M =C+ D ; c=
;
M
M
M 0=C+ R=C +MR+ ER ;
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Bucharest University of Economic Studies
C
c
+1
M
C+ D
D
1c
m=
=
=
=

M 0 C+ MR+ ER C MR ER
c
+
+
+r +e
D D
D
1c MR

r
r
( MR+ e)+c( MR+ e) c

1
m=

5. Quantitative theory of money:

1
M v =p Y when money supply=money demand ( liquidity )= M =L= p Y
v
6. According to the ECB, the quantitative theory of money is expressed dynamically as:
%M + v = + Y
where =2

(inflation target) and Y =2

(potential growth)

Solved exercises (all of the below exercises have been translated from the referenced book
at the end of this document):
10/24. We consider the following financial assets. Which of the below can be classified as money
according to the definition of money of the European Union?
1. Deposits with a maturity of up to 2 years;
2. Repo loans;
3. Cash/Currency in circulation;
4. Cash at MFI (monetary financial institutions);
5. Money in current accounts;
6. Overnight deposits
7. Monetary market mutual funds units
8. Stocks from the stock market;
9. Deposits with a maturity of 2 years;
10. Government securities;
11. Credit titles with a maturity of up to 6 years;
12. Deposits with a withdrawal notice of 3 months;
13. Meal tickets;

Faculty of Finance and Banking

Bucharest University of Economic Studies
11/24. Determine the weight of term deposits in the intermediate money, knowing that the
M1
M2
multiplier of monetary base over
is 2.5 and the multiplier of monetary base over
is
4.
12/24. We know the following information regarding money: the multiplier of monetary base
over broad money is 4.15; current accounts of credit institutions at the Central Bank represent
25% from the monetary base and cash in circulation amounts to 15,000 bn. lei. Knowing that
GDP is 311,250 bn. lei, compute:
a. Broad money;
b. Money velocity;
c. Percent change of broad money, if the Central Bank decides to inject an amount of 5,000 bn.
lei.
13/24. How does the nominal GPD modify if the money supply increases by 20% and the money
velocity diminishes by 30%?
14/25. We have the following information for the Euro Zone economy: the level of overnight
deposits is equal to that of overnight deposits in foreign currency, cash represents 30% of
overnight deposits and the ratio between narrow money and term deposits is 4. Intermediate
money is 97,500 monetary units (m.u.). We also know that if the monetary base increases with 1
m.u., then the large monetary mass increases by 5.5 m.u. Determine:
a. Overnight deposits, term deposits and narrow money;
b. The percentage change of money velocity when GDP increases by 5% and the money supply
remains the same;
c. The relative change of broad money if the Central Bank decides to increase the monetary base
by 10%, all of the other data remaining the same.
15/25. We have the following information: the minimum reserve ratio is 18%, the cash deposits
ratio is 1/5, excess reserves deposits ratio is 0.02. Determine:
a. A relation between the monetary base and the broad money;
b. How does the broad money change if the cash deposit ratio increases to 2/5 and the
percentage change of the monetary base is 10%?
c. How does the money multiplier and the broad money modify if the minimum reserve ratio
diminishes by 2 percentage points and all of the other information remains unchanged.
16/25. During the period January November 2008, the minimum reserve ratio for deposits in
lei was 20% and the money multiplier was approx. 3.325.
a. What is the quantity of money created in the economy as a result of a liquidity injection of
100,000 m.u. from the Central Bank?
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b. During November 2008, the Board of the Central Bank decided to change the minimum
reserve ratio for deposits in lei by 2 percentage points in order to increase the credit potential in
the economy. How does the money multiplier change? (Consider e=0).
17/26. Consider the case of a fictive country Moneymania, having as national currency the peso.
The Central Bank of this country wants to expand the money supply and buys 10 million pesos
(worth in treasury bills) from commercial banks. At the same time, the commercial banks sell
1 million euro (worth in treasury bills) to foreign banks (abroad). This money will be found in
the economy multiplied through the giving out of loans and creation of deposits. We also know
that the cash preference in Moneymania is 35%, the minimum reserve ratio is the same for the
deposits in euro and peso and it equals to 25%, while 1 euro = 10 pesos.
a. Compute the credit potential in the two currencies generated by the amounts of money which
reached the banking system;
b. We assume that the Central Bank wants to limit lending in euros and changes the minimum
reserve ratio for deposits in euro to 15 percentage points. How does the ratio between the credit
potential in foreign and national currencies change?
c. We assume that the Central Bank wants to encourage credit in national currency and changes
the minimum reserve ratio for deposits in peso by 5 percentage points. By how much does the
credit potential in pesos increase in comparison to the initial situation?
d. How does the credit potential change if the cash preference for Moneymania increases to
45%?
18/26. A Central Bank forecasts an economic growth of 3.4% and an inflation rate of 1.5% for
the next year. It decides that through its monetary policy to generate an increase of 3% in money
supply.
a. Decide whether these values are consistent with the quantitative theory of money;
b. Considering that the Central Bank targets the monetary aggregates and keeps its decision to
generate an increase in money supply of only 3% and that its monetary policy objective is to
obtain an inflation rate of 1.5%, compute the economic growth sacrifice that the Central Bank
would have to make in order for the quantitative theory of money to verify.
19/26. At the end of 2008, the Central Bank of a country needs to establish its money supply
growth objective. The Central Banks monetary policy is based on the following money supply
growth equation:
M t +1/ t=120+ 0.7 M t /t 1

where:

M t +1/ t

is the absolute change of money in period t+1 over period t .

It is also known that in 2008 inflation was 7%, real economic growth was 5%, the money
velocity remained constant in comparison to the value in 2007 and the money supply at the end
of year 2007 was equal to 2.000 m.u. Determine:
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Bucharest University of Economic Studies
a. The aimed growth of money for the year 2009;
b. The forecasted value of money for the end of year 2009;
c. What is the money increase on the long term (when t ) ? Does the money value from
2008 matter in determining this figure?
20/27.
a. Identify the factors which influence the money demand (L) according to the quantitative
theory of money;
b. How did the theory concerning the money demand evolved or what are the factors which
influence the money demand in the Keynesian vision?
c. We assume that the money demand is given by the following equation:
L=0.2 Y 1500 r
where Y

is the level of income and r

is the interest rate.

i). Comment this relation;

ii). How does money demand change when the real GDP increases with 100 m.u. and the
interest rate remains the same?
iii). Write the money market equilibrium equation.
d. It is known that in economics, the aggregate demand is in an inverse relationship with the
interest rate, as such: Y =80001100 r
i). Comment this relation;
ii). The Central Bank wants to boost economic growth. Knowing that the money supply
equals money demand, how should it modify in order for the real GDP to increase with 500 m.u.
e. It is known that the minimum reserve ratio is 15%, cash preference is 12% and the excess
reserves are 2%. How can the Central Bank determine the desired monetary mass growth from
point d. above?
Proposed applications (all of the below exercises have been translated from the referenced
book at the end of this document):
6/40. The European Central Bank wants to boost the Euro Zone economy and to register a real
economic growth rate of 2.5% / year. The inflation forecast indicates a rate of price increase of
2.5% / year, given a decrease in money velocity of 0.5%.
M3
a. The Board of Governors of the ECB establishes the reference rate for the
aggregate
increase according to the quantitative theory of money. What is this growth rate for the year in
question?

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Bucharest University of Economic Studies
b. Considering the desired growth of the money supply, by how much does the ECB need to
increase the monetary base if the money multiplier remains constant?
c. Assuming that the money multiplier decreases by 0.5%, by how much does the monetary base
need to increase in order to ensure the desire growth of the money supply?
d. How can the ECB increase the monetary base?
7/41. During 14.03.1984 27.08.2008, the average monthly rate of monetary base increase
created by the Federal Reserve System was 0.5%. We know the following data concerning the
total monetary base at the end of each of the following months in the US:
sept , 2008

M0

=939.4 bn .USD ;

oct , 2008

M0

nov , 2008

=1174.11 bn .USD ; M 0

=1506.54 bn . USD

a. Compute the monthly growth rates of the monetary base in October 2008 and November 2008
and compare them with the average growth rate of the monetary base during
March 1984 August 2008. Explain the result.
b. Do you think that the growth rate of the money supply was the same or bigger in comparison
to the growth rate of the money supply? Explain.
c. Do you consider that the increase of the monetary base can lead to stagflation? Explain.
8/41. We consider the following financial assets. Which of the below can be classified as money
according to the broad money definition in Romania?
1. Mutual funds units activating on the Romanian money and capital markets;
2. Reverse repo agreements;
3. Cash in circulation;
4. Cash in the banks vault;
5. Current accounts;
6. Term deposits with a maturity bigger than 2 years;
7. Foreign currency savings accounts;
8. Treasury certificates;
9. Gift tickets;
10. Foreign currency term deposits with a maturity smaller than 2 years;
11. Bonds from the capital market;
12. Minimum reserve rates;
13. Accounts from commercial banks at the NBR (National Bank of Romania);
9/42. The monthly bulletin published by the NBR for October 2008 contains the following:
Money component
Value (mil. lei)
Cash in MFI vault
3.414,50
Cash in circulation
25.229,80
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Bucharest University of Economic Studies
Current accounts of credit institutions
Overnight deposits
Deposits with an agreed maturity of up to 2 years
Loans from repos + money market mutual funds
units + issued negotiable bills with a maturity of
up to and including 2 years
a. Compute the monetary base

M0

b. Compute the monetary aggregates

20.892,10
67.171,00
71969,40
357,20

;
M1

and

M2

c. Which component has a bigger weight in the narrow money: cash or virtual money?
M1
M2
M3
d. Calculate the money multiplier with respect to
,
and
;
e. What is the weight of the less liquid 3 components of

M3

f. Is the money supply included in the monetary aggregates

from the total money supply?

M1

M2

and

M3

10/43. It is known that there is a direct relation between money and the GDP level from an
economy. We assume that the level of income depends on money according to the following
simplified expression: Y =7000+ 0.8 M .
a. Calculate by how much the GDP changes when the Central Bank decides to increase the
monetary base with 1000 monetary units. It is also known that the minimum reserve ratio is
20%, the escape coefficient is 25% and the excess reserves rate is 3%;
b. Establish how the monetary authority would prefer the monetary multiplier to behave from the
monetary policy implementation perspective: constant, predictable, very volatile, stochastic,
unpredictable. How do you think the multiplier really is?
References: Bojeteanu, Elena; Ciuril, Nicoleta; Grigore, Alina; Dumitrescu, Bogdan; Trifan
Alina - MONED i BNCI, Culegere de aplicaii, Editura Didactic i Pedagogic, 2009 (in
Romanian).