Question

1). Suppose everything else equal; a) the Central Bank raises the reserve requirement to 20 percent, b) the currency deposit ratio rises to 60 percent. Which development, a) or b) will affect the money multiplier more? Why?

2). Suppose the Central Bank of Turkey starts to pay interest on reserves. Under what circumstances this would affect the short term policy interest rate?

Answer 1

Answer (1)
Money multiplier represents the maximum extent to which the money supply is affected by any change in the amount of deposits.
Reserve ratio is the percentage of deposits that banks keep in liquid reserves. It can lend out an amount equals to excess reserves which equals (1 − required reserves).
Higher the required reserve ratio, lesser the excess reserves, lesser the banks can lend as loans, and lower the money multiplier.
Lower the required reserve ratio, higher the excess reserves, more the banks can lend, and higher is the money multiplier.
Hence	Money Multiplier = 1/Required Reserve Ratio
If the reserve requirement is 20%,then this means every one dollar of reserves should have $10 in money supply deposits.
Currency deposit ratio shows the amount of currency that people hold as a proportion of aggregate deposits.
An increase in the currency deposit ratio will decrease the money multiplier because people tend to hold more cash, and there will be fewer deposits in banks
Money multiplier =	1 + currency deposit ratio
	reserve ratio + currency deposit ratio
If only reserve requirement rises to20%, then Money Multiplier will be 5 (1/0.20)
If currency deposit rises to 60% assuming the reserve requirement is 20%, then Money Multiplier will be 2 {(1+0.60)/(0.20+0.60)}
Hence the raising of reserve requirement by central bank will affect Money multiplier more.