Question

1. Consider a banking system with the following characteristics:

Currency in circulation: $500 million

Checkable Deposits: $1,200 million

Bank Reserves: $200 million

Reserve Requirement: 10%

1. Calculate the following. Make sure to show your work.

   1. Currency ratio

   2. Excess reserve ratio

   3. Monetary base

   4. Money multiplier

   5. M1 money supply

2. Repeat the calculations in part a above, but assuming that households now decide to hold more in currency in circulation: $600 million. What can we conclude about the effect that this change in the public’s preference for currency will have on the money supply? Briefly explain.

Answer 1

Calculation of :

A) Currency Ratio = Currency in Circulation / Checkable Deposits = 500/1200 = 0.4167 = 41.67%

B ) Excess Reserve Ratio = Bank Reserve - Checkable Deposit * Reserve Requirement = 200 - 1200*10% = 200-120 = 80

C) Monetary Base = Currency in Circulation + Checkable Deposit = 500 +1200 = 1700

D ) Money Multiplier = 1/Reserve Requirement = 1/10% = 10 times.

E ) M1 Money Supply = Currency in Circulation + Checkable Deposit = 500 +1200 =1700

If currency in circulation is increased to $ 600 , Chequable deposit will reduce to $1100

A) Currency Ratio = Currency in Circulation / Checkable Deposits = 600/1100 = 0.5454 = 54.54%

B ) Excess Reserve Ratio = Bank Reserve - Checkable Deposit * Reserve Requirement = 200 - 1100*10% = 200-110 = 90

C) Monetary Base = Currency in Circulation + Checkable Deposit = 600 +1100 = 1700

D ) Money Multiplier = 1/Reserve Requirement = 1/10% = 10 times.

E ) M1 Money Supply = Currency in Circulation + Checkable Deposit = 600 +1100 =1700.

Money Supply depends on chequable deposit , higher the deposit higher the money supply . In this case as money in circulation is increased , this results in decrease in checkable deposit hence reduction in money supply.