Question

In: Economics

The Fed wants to increase the money supply (which is currently $7,000) by $250. The money...

The Fed wants to increase the money supply (which is currently $7,000) by $250. The money multiplier is 3, and people hold no cash. For each 1 percentage point the discount rate falls, banks borrow an additional $10. Explain how the Fed can achieve its goals using the following tools:

a. Change the reserve requirement.

Instructions: Enter your response rounded to the nearest whole number.

The Fed should (lower or raise) the reserve requirement to ______ percent.

b. Change the discount rate.

Instructions: Enter your response rounded to two decimal places.

The Fed should (raise or lower) the rate by _____ percentage points.

c. Use open market operations.

Instructions: Enter your response rounded to two decimal places.

The Fed should (buy or sell) $________ worth of bonds.

Expert Solution

a). Answer :- Lower the reserve requirement by Fed = 1.14942 % (Rounded off to 1 %).

Explanation :- Current reserve requirement = 1 / Money multiplier.

= 1 / 3

= 33.33333 % (approx).

Revised reserve requirement = 33.33333 * 7000 / 7250

= 0.3218391 i.e., 32.18391 % (approx)

Lowering of reserve requirement by 1.14942 % (33.33333 % - 32.18391 %) by Fed will increase the money supply. (1.14942 % rounded off to 1 %).

Conclusion :- Lowering of reserve requirement by 1 % (approx) by the Fed will increase the money supply.

b). Answer :- Lowering of discount rate by Fed = 8.33 % (approx).

Explanation :- Increase in reserves by Fed = 250 / 3

= $ 83.3333 (approx).

Lowering of discount rate by Fed = 83.3333 / 10

= 8.33 % (approx).

Conclusion :- Lowering of discount rate by 8.33 % by the Fed will increase reserves in the banking system in an economy which in turn will increase the overall money supply in an economy.

c). Answer :- Buy $ 83.33 worth of bonds.

Explanation :- Fed should buy bonds worth $ 83.33 (250 / 3) to increase money supply in economy. Buying of bonds worth $ 83.33 by the Fed will increase reserves in banking system in economy which in turn will increase the total money supply in economy.

Conclusion :- Buying bonds worth $ 83.33 by the Fed will increase money supply in an economy.

Rahul Sunny answered 2 years ago

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