Question

Problem 4 (ii)

Assume the required reserve ratio is one-third, M1 multiplier is 2, currency in circulation is $300 billion, and checkable deposits are $900 billion. What the fed has to do with the required reserve ratio to increase money multiplier to 3. Provide numerical answer

Answer 1

M1 money Multiplier, m = (1+C)/(rr+ER+C)

C= currency in circulation/checkable deposit = 300/900 = 1/3

rr = 1/3 = required reserve ratio

Let, ER= k

Therefore, using the above formula we'll get the value of k.

2 = [1+(1/3)] / [(1/3)+k+(1/3)]

Or, 2 = (4/3)/[(2/3)+k]

Or, 2[(2/3)+k] = (4/3)

Or, (4/3)+2k = (4/3)

Or, K= 0

Therefore, ER=0

If, m=3,

Then, 3= [1+(1/3)] / [(rr+0+(1/3)]

Or, 3= (4/3) / [rr+(1/3)]

Or, 3rr + 1 = 4/3

Or, 3rr = (4/3)-1 = (1/3)

Or, rr= (1/3)/3 = 1/9

Therefore, fed has to decrease the required reserve ratio to (1/9).