Question

Q:Consider the following monetary situation:
-The currency-to-deposit ratio is 1\4
-Required reserve ratio is 1\4
-The monetary base is 9 trillion
-Banks hold no excess reserves

a) Compute currency in circulation, checking deposits, M1, and the money
multiplier
b) Jerome Powell sells $100 billion worth of tbills. Compute what impact (sign
and magnitude) this has on the money supply. If the Fed sells tbills, are
they attempting to raise or lower the Fed funds rate?

Answer 1

Let the deposits be D

Currency becomes 25% of D or 0.25D and total reserves = required reserves = 25% of D or 0.25D. Monetray base = 9 trillion

MB = C + R

9 T = 0.25D + 0.25D

D = 9/0.5 = 18 trillion

R = 0.25*18 = 4.5 trillion and C = 4.5 trillion

Multiplier = 1 + C-D/C-D + R-D = (1 + 25%)/(25% + 25%) = 2.5

Money supply = M1 = C + D = 4.5 + 18 = 22.5

a) We have currency in circulation= 4.5 trillion , checking deposits = 18 trillion, M1 = 22.5 trillion, and the money
multiplier = 2.5

b) Jerome Powell sells $100 billion worth of tbills. This will reduce money supply M1 by 100*2.5 = 250 billion. If the Fed sells tbills, they attempting to raise the Fed funds rate.