Question

If the initial stock of money is $1 billion, with all money in the form of demand deposits and r* = .5, what will the new money stock be if public currency holdings increase from$0 to $400 million? (Assume a constant monetary base.)

Answer 1

Here we consider initial stock as initial deposit is $1 billion, and required reserve ratio i.e. r* = 0.5.

Formula for calculation,

Demand deposits = Initial Deposit * Reserved requirement ratio

Now substituting the values in the formula.

= $1 billion * 0.5

= 500 million.

To find out new money stock we have one more formula. (assume public currency holding is $ 300 million)

Then,

M₁ = Demand deposits + Currency with Public.

                      = $ 500 million + $ 300 million

                       = $ 800 million

So the new stock of money in circulation is $ 800 million.