Question

In Tivland, currency held by the public is 2,000 niara, bank reserves are 300 niara, and the desired (and current) reserve/deposit ratio is 15 percent. If commercial banks borrow 100 niara in reserves from the Central Bank through discount window lending, then the money supply in Tivland will ________, assuming that the public does not wish to change the amount of currency it holds.

A) increase to 3,133 niara

B) increase to 4,100 niara

C) increase to 4,667 niara

D) decrease to 1,900 niara

Please show calculation

Answer 1

Bank reserves = 300 niara

Reserve/deposit ratio = 15 percent or 0.15

Deposit = Bank reserves/reserve-deposit ratio

Deposit = 300/0.15 = 2,000 niara

Money multiplier = 1/reserve-deposit ratio

Money multiplier = 1/0.15 = 6.67

Commercial bank has borrowed 100 niara in reserves from central bank.

These are excess reserves with the central bank.

if bank lends these excess reserves then,

Increase in money supply = Increase in reserves * Money multiplier = 100 * 6.67 = 667 niara

Total money supply = Currency + Deposit + Increase in the money supply

Total money supply = 2,000 + 2,000 + 667 = 4,667 niara

So,

The money supply in Tivland will increase to 4,667 niara

Hence, the correct answer is the option (c).