Question

# Consider an economy where banks keep 25% of deposits as reserves. Currency is 50 billion pesos,...

Consider an economy where banks keep 25% of deposits as reserves. Currency is 50 billion pesos, which constitutes 10% of the monetary base. If the central bank buys 10 billion pesos worth of securities, calculate the percentage change in the monetary base and the percentage change in the money supply assuming that the currency-deposit ratio and the reserve-deposit ratio stay unchanged.

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Answer #1

Answer:

Given,

Currency = 50 billon (i.e., 10% of monetary base)

Therefore,

Monetary base(in billions)

= (100/10) x 50

= 500 billions

Now, central bank buys 10 billion

That remains with 500 - 10 = 490 billions of monetary base.

% Change in monetary base

= ( Change in base / Old base ) x 100

= [ (500 - 490) / 500 ] x 100

= 2%

[ Note :  There is no % change in money supply, as reserve ratio is given constant.

Money supply increases, when reserve ratio decreases, and vice versa ]

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