Question

You are given the following information about the economy of​ Nocoin

The banks have deposits of​ $300 billion. Their reserves are​ $15 billion, two thirds of which is in deposits with the central bank. Households and firms hold​ $30 billion in bank notes. There are no​ coins!

  The banks have no excess reserves.

Suppose that the central bank in Nocoin increases bank reserves by​ $0.5 billion.

Explain why the change in the quantity of money is not equal to the change in the monetary base.

Calculate the money multiplier.

The quantity of money​ ______. The change in the quantity of money is not equal to the change in the monetary base because​ ______.

A.

​decreases; an increase in monetary base brings about a decrease in the quantity of money

B.

​increases; the components of the monetary base are not the components of the quantity of money

C.

​decreases; money includes currency but the monetary base does not include currency

D.

​increases; when bank reserves​ increase, banks loan out their excess reserves and a multiplier process ensues

The money multiplier is___

Answer 1

The money supply (M) consists of both bank deposits (D) and the currency in circulation (C). The monetary base (B) consists of bank reserves (R) and currency in circulation (C).

Therefore, M = C + D and B = C + R

When the central bank in nocoin increases bank reserves (R) by $0.5 billions, it will increase the monetary base by the same amount.

Change in money supply = change in monetary base * money multiplier

Therefore, the change in the quantity of money is not equal to the change in the monetary base.

Money multiplier = 1/ required reserve ratio

Given that, two - thirds of bank reserves are in deposit with the central bank. Therefore, required reserve ratio = 2/3. Money multiplier = 1/(2/3) = 3/2 = 1.5

Answer: option D