Question

a) Jane deposited $1,000 in paper currency (50 x $20 bills) into her demand deposit checking account at Chase Bank. Did her deposit change the amount of M1 in the economy, if yes by how much? ( one sentence) b) The Reserve Requirement is 20%. How much money can Chase Bank lend out after Jane's $1000 deposit? ( one sentence) c) Given the 20% Reserve Requirement, what is the maximum amount of new M1 that can be created through banks giving out loans as a result of Jane's deposit of her $1,000 in paper currency into her demand deposit checking account at Chase? Explain how this growth in M1 takes place. (5-7 sentences) d) What is the money multiplier(MM) or demand deposit expansion multiplier(DDEM) if the reserve requirement is Res. Req. MM/DDEM 1) 5% 2) 10% 3) 20% 4) 25%

Answer 1

Answer a. Her deposit didn't change the amount of M1 because earlier that paper currency was a part of M1 as currency in circulation so this deposit reduce currency in circulation but ncrease demand deposit balance . Both currency in circulation and demand deposits comes under the definition of M1.

Answer b. Bank can lend out $800.

Required reserve is 20% of $1000 that is $200.

Excess reserve to be lend out= $1000-$200=$800

Answer c. The maximum amount of M1 that would be created by Jane's deposit $4000.

Explanation- no bank can lend out the entire deposit. Every bank has to maintain a required reserve from each demand deposit and the rest ecess reserve can be offered to public for lending and this cycle continues untill the exces reserve become nil.

Money supply= excess reserve/reserve ratio

= $800/20×100 =$4000.

Answer d. Money multiplier will be

If Resrve requirement is 5 % --- m= 1/reserve ratio

=1/5×100= 20

If reserve requirement is 10% -- M=1/10%= 10

If Resrve requirement is 20%--m=1/20%%= 5

If reserve requirement is 25%--m=1/25%= 4.