Question

Assume money supply (M) is $1,000 billion, total bank deposits (D) are $800 billion and the required reserve-deposit ratio (rr) is 20% and cash-deposit ratio (cr) is 25%. If the Bank of Canada purchases $3 million worth of Treasury bills, by how much the banking system creates total money supply?

Answer 1

Cash-deposit ratio (cr) = 25% or 0.25

Required reserve ratio (rr) = 20% or 0.20

Calculate the money multiplier -

mm = (1+ cr)/(cr + rr)

mm = (1 + 0.25)/(0.25 + 0.20)

mm = 1.25/0.45

mm = 2.78

The money multiplier is 2.78

Amount of Treasury bills purchased = $3 million

Calculate the total money supply to be created -

Total money supply to be created = Amount of Treasury bills purchased * money multiplier

Total money supply to be created = $3 million * 2.78 = $8.34 million

Thus,

The total money supply to be created is $8.34 million.