Question

Suppose that there is currently $900 billion in circulation, $700 billion in deposits, $30 billion in excess reserves, and $80 billion

in required reserves.

a. Calculate each of the following:

Reserves _______900 + 700 = $1600 billion____________________

Monetary Base _______________________

Money Multiplier ______________________

Money Supply ________________________

b. Suppose that banks have borrowed $40 billion of their total reserves from the Fed. What’s the non-borrowed Monetary Base?

c. Suppose that banks eliminate their excess reserves, using them to payback most of the borrowed reserves from the Fed.

Calculate each of the following:

Reserves ___________________________

Money Multiplier _____________________

Money Supply ______________________

Borrowed Reserves ___________________

d. Explain why the money multiplier from part c is greater than the money multiplier in part a. Also, explain what/why happened to

the money supply.

Answer 1

First Case: (a)

Total Reserves: Excess reserves + Required reserves = $(30 + 80) = $110

Money Supply : Currency in circulation  + Checkable deposits

$(900 + 700) Billion = $1600 Billion

Monetary Base: Currency in circulation + Total Reseves

$(900 + 80 + 30) Billion = $1010 Billion

Currency deposit ratio = Currency in circulation / deposits = $(900/700) = $1.286

Excess reserve ratio = Excess reserves / deposits. = $(30/700) = $0.043

Required reserve ratio = Required reserves / deposits = $(80/700) = 0.114

Money Multiplier = (1 + Currency deposit ratio) / (Required reserve ratio + Excess reserve ratio + Currency deposit ratio)

= (1 + 1.286) / (0.114 + 0.043 + 1.286) = 1.58

(b) Banks have borrowed $40 billion of their total reserves from the Fed. So, deposits gets reduced to

$(700 - 40) = $660.

As a result, the currency circulation gets increased to $(900 + 40) = $940

2nd Case:

Now the bank releases their excess demand to pay back the Fed.

Total Reserves: Excess reserves + Required reserves = $(0 + 80) = $80

Money Supply : Currency in circulation  + Checkable deposits

$(940 + 700) Billion = $1640 Billion

Monetary Base = $(940 + 80) = $1020

Currency deposit ratio = Currency in circulation / deposits = $(940/700) = $1.343

Excess reserve ratio = Excess reserves / deposits. = $(0/700) = $0

Required reserve ratio = Required reserves / deposits = $(80/700) = 0.114

Money Multiplier = (1 + Currency deposit ratio) / (Required reserve ratio + Excess reserve ratio + Currency deposit ratio)

= (1 + 1.343) / (0.343 + 0 + 0.114) = 1.60

Here, money mutiplier is greater in 2nd case wrt to first case because the excess deposit has been transferred to the money market. And as we know, the money supply is proportional to the monetary base. Thus, an increase in the monetary base increases the money supply.