Question

Suppose that the currency in the hands of nonbank public is $4 billion that accounts for 5 percent of their total checkable deposits. Suppose that the required reserve ratio is 20 percent. Banks do not hold any excess reserves. Calculate the value of total checkable deposits, reserves, monetary base, and money supply? What is the value of the money multiplier, m ? Now, suppose the banks decide to hold 5 percent of total checkable deposits as excess reserves. How does this change affect total reserves, monetary base, and money supply and why? Calculate their respective values. What happens to the money multiplier?

Answer 1

currency in hand = $4 billion which is 5% of chequable deposits

Total chequable deposits = 4×100÷5=$ 80 billion

Reserve= 20%0f total chequable deposits

20×80÷100=$16billion

monetary base include total physical money in the economy including cash held by commercial banks in reserves

monetary base =80+4 = $84 billion

mone supply refers to money circulating in the economy. It doesn't include cash reserves of commercial banks

money supply = (80-16) + 4=$68 billion

money multiplier= 1/crr= 1/20%=5

decion of banks 5%of chequable deposits as excess reserves

i when there is ncrease reserves by 5%. total reserves will be 25%of chequable deposits =25/100×80=$20 billion

This change does not affect does not affect monetary base ie 80 +4 =$84 billion

money supply will reduce because of increase in reserve from 16 to 20 . new money supply=(80-20)+4=$64 billion

money multiplier will fal because of rise in reserve from 20% to 25%l new multiplier=1/25%= 4