Question

Suppose that currency in circulation is $800 billion, the amount of checkable deposits is $1200 billion, the required reserve ratio is 10% and excess reserves are $12 billion.

a. Calculate the money supply, the currency-to-deposit ratio, the excess reserve ratio, and the money multiplier.

b. Suppose the central bank conducts an unusually large open market purchase of bonds held by banks of $2000 billion due to a sharp contraction in the economy. Assuming the ratios you calculated in part (a) remain the same, predict the effect on the money supply.

c. Suppose the central bank conducts the same open market purchase as in part (b), except that banks choose to hold all of these proceeds as excess reserves rather than loan them out, due to fear of a financial crisis and bank run. Assuming that currency and deposits remain the same, what happens to the amount of excess reserves, the excess reserve ratio, the money supply, and the money multiplier?

d. Go to the FRED web site and graph the Fed's M1 multiplier. How does the scenario in part c relate to the graph you created?

Answer 1