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In: Economics

1 A)Assume the required reserve ratio is 20% and the Open Market Committee of the FED...

1 A)Assume the required reserve ratio is 20% and the Open Market Committee of the FED buys $300 billion in bonds from the public. Assuming banks give out as many loans as possible, what is the total change in the money supply? What is the total change in Transaction Accounts? If the M1 was original $8500 billion, what is the new M1 ( After the change)? You must show your work.

B)Assume the required reserve ratio is 10% and the Open Market Committee of the FED buys $50 billion in bonds from the public. Assuming banks give out as many loans as possible, what is the total change in the money supply? What is the total change in Transaction Accounts? If the M1 was original $9500 billion, what is the new M1 ( After the change)? You must show your work.

Solutions

Expert Solution

Question 1

Fed buys $300 billion in bonds from the public.

Fed pays for this using to the public using through banks.

So, initially, the deposits and reserves will increase by $300 billion.

Reserves are part of monetary base.

So, monetary base will increase by $300 billion.

Reserve ratio = 20% or 0.20

Money multiplier (m) = 1/reserve ratio = 1/0.20 = 5

The money multiplier is 5.

Calculate the increase in money supply -

Increase in money supply = Increase in monetary base * Money multiplier = $300 billion * 5 = $1,500 billion

Thus,

The total change in money supply is $1,500 billion.

The new deposits obtained by bank due to this purchase of bonds by Fed would be utilized to make loans reasulting in additional increase in deposits because when bank make loan, it opens the deposit account in the name of borrower with the amount of loan.

Calculate the total increase in transaction accounts or deposits -

Total increase in deposits = Initial increase in deposits * Money multiplier = $300 billion * 5 = $1,500 billion

Thus,

The total change in transaction accounts is $1,500 billion.

Initial M1 is $8500 billion

Calculate new M1 -

New M1 = Initial M1 + Total change in money supply = $8500 billion + $1500 billion = $10,000 billion

Thus,

The new M1 is $10,000 billion.

(B)

Fed buys $50 billion in bonds from the public.

Fed pays for this using to the public using through banks.

So, initially, the deposits and reserves will increase by $50 billion.

Reserves are part of monetary base.

So, monetary base will increase by $50 billion.

Reserve ratio = 10% or 0.10

Money multiplier (m) = 1/reserve ratio = 1/0.10 = 10

The money multiplier is 10.

Calculate the increase in money supply -

Increase in money supply = Increase in monetary base * Money multiplier = $50 billion * 10 = $500 billion

Thus,

The total change in money supply is $500 billion.

Calculate the total increase in transaction accounts or deposits -

Total increase in deposits = Initial increase in deposits * Money multiplier = $50 billion * 10 = $500 billion

Thus,

The total change in transaction accounts is $500 billion.

Initial M1 is $9500 billion

Calculate new M1 -

New M1 = Initial M1 + Total change in money supply = $9500 billion + $500 billion = $10,000 billion

Thus,

The new M1 is $10,000 billion.

Rahul Sunny answered 1 year ago

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