Question

1. Money Supply Problem:

Suppose that the required reserve ratio is 11%, currency in circulation is $620 billion, the amount of checkable deposits is $900 billion, and excess reserves are $25 billion.

1. The money supply is $________________
2. The currency deposit ratio is ___________________
3. The excess reserves ratio is ___________________
4. The money multiplier is ____________________

Suppose the central bank conducts an unusual large open market purchase of bonds held by banks of $1485 billion due to a sharp contraction in the economy.  Assuming the ratios you calculated in the previous steps are the same, the money supply should ________________ (increase or decrease) to $_________________ billion.

Suppose the central bank conducts the same open market purchase as previously, except that banks choose to hold all of these proceeds as excess reserves rather than loan them out, due to fear of a financial crisis.

Assuming that currency and deposits remain the same, the new amount of excess reserves is $___________________ billion.

The new excess reserve ratio is ___________

The money multiplier is _________________

The money supply is $___________________

Answer 1

a. Money supply = Currency in circulation + Checkable deposits = 620 + 900 = $1,520 billion.

b. The currency deposit ratio = (Currency in circulation / Checkable deposits) = (620 / 900) = 0.689.

c. The excess reserves ratio = (Exess Reserves / Checkable Deposits) = (25 / 900) = 0.03.

d. Money multiplier = [(1 + c ) / (r + e + c)]

                               = [(1 + 0.689 ) / (0.11 + 0.03 + 0.689)]

                               =(1.689 / 0.829)

                               = 2.037

The money supply should increase to $3,024.95 billion (i.e., 1,485 * 2.037).

The new excess reserves = 1,485 + 25 = $1,510 billion.

The new excess reserves ratio = (1,510 / 900) = 1.678.

The money multiplier = [(1 + c ) / (r + e + c)]

                               = [(1 + 0.689 ) / (0.11 + 1.678 + 0.689)]

                               =(1.689 / 2.477)

                               = 0.68

The money supply = 620 + 900 = $1,520 billion.