Question

supposethatcurrencyincirculationis$600billion,theamountof chequable deposits is $900 billion, and excess reserves are $15 billion and the desired reserve ratio is 10%.

a. Calculate the money supply, the currency 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 $1400 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 these proceeds as excess reserves rather than loan them out due to fear of a financial crisis. 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. During the financial crisis in 2008, the Federal Reserve began injecting the banking system with massive amounts of liquidity, and at the same time, very little lending occurred. As a result, the M1 money multiplier was below one for most of the time from October 2008 through 2011. How does this scenario relate to your answer to part (c)?

Answer 1

a. Money supply= Currency+Chechable deposit

=$600B+$900B = $1500B

Currency deposit ratio= currency/Chechable deposit

=$600B/$900B = 66.7%

Excess reserve ratio = excess reserve ratio/Chechable deposit

°$15B/$900B = 1.7%

Monetary base = currency+total reserve

=$600B+$15B+$900B×10% = $705B

Money multiplier = Money supply/ Monetary base

=$1500B/$705B = 2.13

b. This purchase will increase the monetary base by $1400B.hence with a money multiplier as 2.13, this will increase the money supply by $1400B×2.13 = 2982.

C. After this transaction,

Excess reserves = $15B+$1400B=$1415B

Excess reserve ratio= $1415B/$900B= 157.22%

Money supply=$600B+$900B=$1500B

Monetary base=$600B+$1415B+$900B×10% = $2105B

Money multiplier= money supply/monetary base = 0.71

d. This is exactly shown in part c.