In: Economics
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.
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.