Question

6. Suppose the reserve requirement rate (rr) is 0.2, the quantity of money (M1) is 100 billion euros and there is no currency in circulation.

Suppose the Central Bank provides an additional 1 billion of reserves to banks. Describe how the quantity of M1 would change and compute the new quantity of M1.

Answer 1

Answer 6

M1 = ((Cr + 1)/(Cr + rr + er))(H) , Assuming er = Excess reserve = 0 and Currency in circulation = 0 => Cr = Currency to deposit Ratio = 0 and H = Monetary Base

Hence In this Case :

M1 = (1/rr)(H)

Now, Suppose the Central Bank provides an additional 1 billion of reserves to banks Hence H = 1 billion

=> M1 = (1/0.2)1 billion = 5 billion

Hence M1 will increase by 5 billion Euros

Hence, New M1 = Initial M1 +  M1 = 100 billion + 5 billion = 105 billion euris

Hence, The new quantity of M1 = 105 billion Euros