Question

An economy requires banks to keep 10% of deposits as reserves. Currency is 50 billion dollars and deposits are 2000 billion dollars.

A) calculate the money supply

B) calculate the monetary base

C) If the central bank sells 20 billion in dollars worth of securities calculate the resulting money supply assuming the currency deposit ratio and the reserve deposit ratio stay the same

Answer 1

A) Money supply = currency + deposits

Currency = 50 billion

Deposits= 2000 billion

Money supply =50+2000

=2050 billion dollars.

B) Monetary base = currency in circulation+ bank reserves

Currency = 50 billion

Bank reserves= 2000 billion*10/100= 200 billion

Monetary base =50+200

=250 billion dollars.  

C)change in money supply= value of securities * money multiplier

Money multiplier=1/ reserve ratio

Reserve ratio = 10%=0.1

Money multiplier=1/0.1=10

Change in money supply =10*20 billion

=2000 billion

* Money supply would fall by 2000 billion.

Remaining money supply= 2050-2000=50 billion