Question

In: Economics

Jeremiah deposits in a bank an amount of $5000 that he had been holding at home...

Jeremiah deposits in a bank an amount of $5000 that he had been holding at home in a jar for a long time.
a. If the banking system is 100 percent reserve, how does the money supply change?
b. If the reserve requirement is 20 percent and the bank holds no excess reserves, how does the money supply change?
c. If the reserve requirement is 20 percent and the bank holds an excess reserve of 2 percent, how does the money supply change?

Solutions

Expert Solution

Q-(A) ANSWER ::

If The Banking system Is 100% Reserve Money Supply Decrease Because All The Deposits That Public Deposited In Their Saving Account Bank Kept All It In Their Reserve So They don't Provide Loans To Consumer So It Decrease the money supply In The Economy.

Q-(B) ANSWER ::

Multiplier = 1/Reserve Ratio

= 1/0.2 = 5

So Money Supply = $5000 * 5

= $25000

=> So If Reserve Ratio Is 20% $25000 New Money Created By Bank Though $5000 Deposit And Require Reserve Is $1000 ($5000*0.2) And Banks Provide all The $4000 ($5000-$1000) As a Loans Because There Are No Excess Reserve Kept By Bank.So If Bank Provide Loans To Its Costumer It Increases Money Supply In The Economy.

Q-(C) ANSWER ::

Multiplier = 1/0.2 = 5

So, Money supply = $5000 * 5

= $25000

=> Require Reserve = $5000 * 0.2 (20/100)

= $1000

=> Excess Reserve = $5000 * 0.02 (2%/100)

= $100

=> Total Reserve = $1000 + $100 = $1100

=> Loans = $5000 - $1100 = $3900

So, When Reserve Ratio Is 20% And Excess Reserve Is 2% The New Money Created By Bank Is $25000. But Total Reserve Is Increased Because Of The Excess Reserve So Bank Provide $3900 Loans To Consumer So Money Supply Is Decrease In comparison To Q-B There Is More Money Supply Because There Are No Excess Reserve. But If We Don't Compare It The Money Supply Is Increase In The Economy By $3900 In The Form Of Loans.


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