Question

Suppose that the currency ratio is .6, the required reserve ratio is .1, the excess-reserve ratio is .3, and the desired ratio of noncheckable deposits to checkable deposits is 4. If the monetary base increases by $500, what is the increase in bank credit? Assume there is no change in bank capital and there is no capital constraint. Show how you got your answer.

Answer 1

Money multiplier = (1 + C-D)/(C-D + R-D + E-D) = (1 + 0.6)/(0.6 + 0.1 + 0.3) = 1.6

Increase in monetary base = 500. Increase in money supply =1,6*500 = 800.

Increase in currency = 800*C-D ratio = 0.6*800 = 480. Increase in checkable deposits = 800 = 480 = $320.

Now the ratio of noncheckable deposits to checkable deposits is 4. Hence increase in noncheckable deposits = 320*4 = 1280. Total of liabilities side = 1280 + 320 = 1600.

Reserves = 320*(0.1 + 0.3) = 128. Bank credit = 1600 - 128 = 1472.