Question

Use the following information about Macroland to answer this question Bank deposits at the central bank $100 million Currency in bank vaults $50 million Currency held by the public 75 million Chequeable deposits 600 million Traveller cheques 5 million

a) What are bank reserves equal to in Macroland?

b) Suppose banks hold no excess reserves in Macroland? What is required reserves ratio given the information in this table?

c) If the public does not change its currency holdings, what will happen to the level of chequeable deposits in Macroland, relative to their initial level, if the central bank of Macroland purchases $ 10 million worth of treasury bills in the open market?

d) If the public does not change its currency holdings, what will happen to the level of chequeable deposits in Macroland, relative to their initial level, if the central bank of Macroland sells $ 5 million worth of treasury bills in the open market?

Answer 1

Answer a. bank reserve = currency in bank vault + deposits with central bank

= $ 50 million + $ 100 million = $150 million

Answer b. As there is no excess reserve in Macroland. Required reserve equal to $150 million as calculated in part a.

Required reserve = $150 million/$600 million × 100

= 25 %

Answer c. If central bank purchase $10 million treasure bills, it will increase the bank reserves by $ 10 million.

Money multiplier = 1/rr = 1/25% = 4

Money supply = excess reserve × money multiplier

= $ 10 million × 4 = $40 million.

This will leads to increase the money supply by $ 40 million.

Answer d. The sale of $5 million treasury bills by central bank will lead to decrease the money supply by

money multiplier = 4 ( calculated in part c)

Moeny supply decrease by = $5 million × 4

=$20 million.