Question

For each event described, determine the affect on the monetary base, the money multiplier, and the money supply. Whether it increases, decreases, may increase or decrease, or no change.

a. The Federal Reserve buys bonds using open market operations.
b. The Fed increases the interest rate it pays banks for holding reserves.
c. The Fed reduces its lending to banks through its Term Auction Facility.
d. Rumors about a computer virus attack on ATMs increase the amount of money people hold as currency rather than demand deposits.
e. The Fed flies a helicopter over 5th Avenue in New York City and drops newly printed $100 bills.

Answer 1

a) When Fed buys bonds using open market operations,the dollar paid will raise the monetary base and it will increase the money supply.There would no change in the money multiplier.

b) When Fed increases the interest rate then this would encourage the bank to hold more reserves which would decrease the money multiplier and it would decrease the money supply.As banks would hold more reserves so the monetary base will increase.

c) When the Fed reduces the lending then the monetary base would decrease which would decrease the money supply and there would be no change in the money multiplier.

d) When people hold more cash the currency deposit ratio would increase the money multiplier and money supply would decrease.Monetary base increases as people hold more cash but decreases as banks hold less reserves so net effect is zero.

e) This would increase the monetary base and money supply and if people deposit the cash in the banks then the money supply would further increase but if people hold it as cash then money multiplier would decrease