Question

The RRR is .20

Suppose he Fed buys a $50,000 bond, but everyone—starting with the initial seller of the bond—keeps 20% of their proceeds in cash instead of their checking accounts. a. How much will checking account deposits increase? b. How much will reserves increase?

for part a) i got $111,111.111 by dividing 40,000/(1 - .64), but am unsure how to do part b)

Answer 1

Proceeds from the sale of the bonds = $50,000

The initial seller holds 20% of the proceeds in cash and deposits the rest in a checking deposit.

Initial deposit = (1-0.20)*$50,000 = 0.80 * $50,000 = $40,000

Required reserve ratio, rr = 0.20

Currency drain ratio, d = 0.20

a) Money multiplier = 1/{1-(1-rr)(1-c)} = 1/{1-(1-0.20)*(1-0.20)} = 1/{1-0.64} = 1/0.36

Total Increase in the deposits = $40,000 * 1/0.36 = $111,111.11

b) Total Increase in reserves = Increase in deposits * required reserve ratio = $111,111.11 * 0.20 = $22,222.22

answered by: anonymous