Question

In a small economy of Panicia, the monetary base is $1,000. People hold a third of their money in the form of currency (and thus two-thirds as bank deposits). Banks hold a third of their deposits in reserves.
Based on tise information, use the following formulas to answer the questions below:

M = mB B=C+R

m = cr +1 , where cr = C , rr = R cr + rr D D

M=C+D
a. What are the reserve-deposit ratio, the currency-deposit ratio, the money multiplier, and the money supply?

b. One day, fear about the banking system strikes the population, and people now want to hold half of their money in the form of currency. If the central bank does nothing, what is the new money supply?

c. If in the face of this panic, the central bank wants to conduct an open market operation to keep the money supply at its original level, does it buy or sell government bonds? Calculate, in dollars, how much the central bank needs to transact.

Answer 1

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