Question

Suppose currently there is $600 Billion currency in circulation, the amount of checkable deposits is $900 Billion. Banks hold $105 Billion in in total reserves of which $15 Billion are excess reserves.

a) Calculate the monetary base, money supply (M1), currency deposit ratio, excess reserve ratio, and the money multiplier

b) Suppose the central bank conducts an unusually large open market operation purchase of $1,400 billion in bonds held by banks to counteract an economic contraction. Assume banks do not change their holdings of excess reserves and consumers don't change their holdings of currency. How does the monetary base change? How does the money supply change?

c) Now assume the same open market operation happens in b), but banks choose to hold all these new funds as excess reserves instead of loaning it out. Assuming currency holdings and deposits remain the same. What happens to excess reserves? What happens to the excess reserve ratio? What happens to the money multiplier? How does the money supply change?

d) How does b) and c) relate to Quantitative Easing and inflation in the US post-2008 crisis.

Answer 1

Suppose currently there is $600 Billion currency in circulation, the amount of checkable deposits is $900 Billion. Banks hold $105 Billion in in total reserves of which $15 Billion are excess reserves.

a) Calculate the monetary base, money supply (M1), currency deposit ratio, excess reserve ratio, and the money multiplier

Ans: Some of the values are already given i.e

Currency = $600 Billion , Checkable Deposites = $900 Billion , Total Reserve = $105 Billion and  Excess reserve = $15 billion

Monetray Base= Currency+ Total Reserve

= $600Billion + $105 Billion

= $ 705 Billion

Money Supply( M1) = Currency + Checkable Deposites

= $600 Billion + $900 Billion

= $1500 Billion

Currency Deposite Ratio = Currency / Checkable Deposite

= $600 Billion/ $900 Billion

= 0.667 i. e 66.7%

Excess Reserve Ratio= excess reserves/checkable deposit

= $15 Billion/ $900 Billion

= 0.017 i.e 1.7%

Money Multiplier = Money Supply / Monetary Base

= $ 1500 Billion/ $705Billion

= 2.13

b) Suppose the central bank conducts an unusually large open market operation purchase of $1,400 billion in bonds held by banks to counteract an economic contraction. Assume banks do not change their holdings of excess reserves and consumers don't change their holdings of currency. How does the monetary base change? How does the money supply change?

Ans: If the Market Operation Purchase of $1400 Billion which will increse the Monetary base i.e $1400 billion with a money multiplier which already calculate in quetion no (a) i.e 2.13

so, In this case Monetary base is multiple with multipler

= $ 1400 billion * 2.13

= $2982 billion it means money supply increase from $1500 billion to $ 2982 Billion

c) Now assume the same open market operation happens in b), but banks choose to hold all these new funds as excess reserves instead of loaning it out. Assuming currency holdings and deposits remain the same. What happens to excess reserves? What happens to the excess reserve ratio? What happens to the money multiplier? How does the money supply change?

Ans: After the Monetary base change the other parameters also changes accordingly

Excess Reserves = $15B+$1400B=$1415B

Excess Reserve Ratio=$1415B/$900B=157.22%

Money Supply=$600B+ $900B=$1500B

Monetary Base=$600B+$1415B+$900B*10%=$2105B

Money Multiplier= Money Supply/Monetary Base

= $1500 Billion / $2105 Billion

= 0.71

d) How does b) and c) relate to Quantitative Easing and inflation in the US post-2008 crisis.

Ans: In Question no B the monetary base is $2982 Billion and question no c the monetary base is changing i.e $2105 billion so this is the same effects in the US post 2008 crisis