Question

Suppose currency is $500 billion, deposits are $700 billion, the reserve requirement is 10%, and excess reserves are $10 billion. Calculate the money supply, currency deposit ratio, excess reserve ratio and the money multiplier. Suppose the central bank conducts an open market purchase of $500 billion. Assume the ratios you calculated stay the same, predict the effect on the money supply.

Answer 1

Money supply = Deposits + Currency in circulation

= 700+500

= $ 1200 billion

Currency deposit ratio = Currency / Deposit *100

= 500/700*100

= 71.43%

Excess reserve ratio = Excess reserve / Deposits * 100

= 10/700*100

= 1.43 %

Money multiplier = 1/ Reserve ratio

= 1/0.10

= 10

If open market purchase is conducted , money supply will rise.

Rise in money supply = 500*10

= $ 5000 billion

Total money supply will rise by $ 5000 billion

In this , $ 500 billion will be rise in reserves and $ 4500 billion will be rise in loans in banking system.