Question

Suppose the country's money supply is equal to $10 million.
The FED buys $4 million worth of bonds from Wells Fargo customers depositing it in their bank accounts.
Wells Fargo then lends out 60% of the new deposits.
At this point:

1. What is the new total money supply?  

2. What is the money multiplier?  

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KeyBank has assets of $101 in reserves, $27 in bonds, and
$600 in loans as well as $370 in Demand Deposits.

3. Given that information, what is KeyBank's Owners' Equity?  

4. If KeyBank sells all its bonds to the FED,
what is the change on the money supply if the money multiplier is 5?  

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5. Suppose Ringo buys a $5000 bond from the FED.
He bought that bond with a check on his demand deposit at Wells Fargo.
If the money multiplier is 5,
then by how much will the money supply change?

Answer 1

Solution:

Since the country's money supply is equal to $10 million.
The FED buys $4 million worth of bonds from Wells Fargo customers depositing it in their bank accounts.

Wells Fargo then lends out 60% of the new deposits.
At this point the required reserve is 40% because bank keep required reserve and lend remaining money.

RR=0.40

Money multiplier= 1/ required reserve

=1/0.40

=2.5

The increase in the money supply by= $4 millions

Total money creation= money multiplier* change in money supply

= 2.5 * $4 million

= $10 millions

(1) New total money supply is:

new total money supply = $10 million + $10 millions

= $20 millions

(2) money multiplier is:

Money multiplier= 1/ required reserve

=1/0.40

=2.5

(3). Key Bank's Owners' Equity is:

Owner's equity = assets - liabilities

Here,

assets of the bank = reserves + bonds + loans

= $101 + $27 + $600

= $728.

Liabilities = Demand Deposits.

= $370.

Owner's equity = assets - liabilities

= $728 - $370

= $358.

(4).If Key Bank sells all its bonds to the FED,  the change on the money supply if the money multiplier is 5:

Change in money supply = value of bonds hold * money multiplier

= $27* 5

= $135.

So,

the money supply will fall by $135 as selling bonds reduce the money supply.

(5)  money supply change is:

Money multiplier = 5

Bond worth = 5000

The money supply will change by = 5000 * 5 = 25000