Question

1. If the reserve ratio at the Toronto Dominion Bank is 2.5% and $40,000 is deposited, how much money is created if all available funds are loaned to firms and individuals?

2. What impact will the decrease in interest rate have on investment, unemployment, GDP, household income, and prices? (increase or decrease)

Answer 1

Ans 1.

Reserve ratio = 2.5 %

Deposits = 40000

Money multiplier = 1 / Reserve ratio

= 1 / 02.5 % = 40

The money supply will increase by 40 × $40,000 = $ 1600000

Ans 2.

When interest rate falls, it becomes cheap to borrow from credit markets. The households, businesses , government now can borrow at lower interest rates. The spending by the market agents will increase the Aggregated Demand in the economy and rise in Real GDP.

a. Decrease in interest rate will lead to increase in business investment spending, increased business spending will shift the Aggregated demand curve to the right.

b. Unemployment rate will fall with decrease in interest rate, because the lower interest rates increases spending by market agents in the economy. This makes businesses to employ more resources to fullfil the demand in the market leading to fall in unemployment rate.

c. Real GDP rises as increase in spending by market participants shift the Aggregated demand curve to the right.

d. Household income will rise as due to rise in GDP will lead to empolying more human resources and income generation , and build up in wage pressure with shift in aggregate demand.

e. Prices will starts to build up when interest rates are lowered , as their will be excess money supply in the economy and credit markets.