Question

In 2007 before the financial crisis, the currency to deposit ratio 1.2, required reserve ratio plus excess reserve ratio is 0.05. the total money supply measured by M1 in 2007 was 1.4 trillion dollar.

(1) Calculate the value of the money multiplier and the value of the money base?

(2) During the financial crisis, the U.S. central bank purchase a large amount of assets, including long term government bonds and mortgate based securities, to provide liquidity to the market and rebuild the market confidence. The money base increases to 2 trillion dollar in January, 2010. If the money multiplier does not change from 2007 to 2010, what is the money 1 supply measured by M1 in January, 2010?

(3) The actual official reported M1 in January 2010 was $1.7 trillion dollar. Given this number, what is the money multiplier in January, 2010? Explain why there is such a significant difference between the official reported M1 and the M1 you calculated in question (2)?

Answer 1

ANSWER

1.)Money Multiplier =   (1+c) / (r+c+e)

                       = (1+1.2) / 1.2+0.05)

                         = (2.2) / (1.25)

                          = 2

Thus, Money Multiplier Value = 2

Money Supply = Monetary Base*Money Multiplier

                       1.4   = 2*Monetary Base

Monetary Base = 1.4/2

                                = 0 .7

Monetary Base is 0.7 Trillion.

2)Money multiplier is 2

and Monetary base increases by 2 Trillion

So increase in money supply = 2*2

INSCREASE IN MONEY SUPLY= $4 Trillion

3)Such difference between two distinct calculation might have been contributed by leakages in money multiplier. People tendency to hold money in cash might have increased.