Question

# Suppose the required reserve ratio is 10%, excess reserves holdings are 65% of deposits, and currency...

Suppose the required reserve ratio is 10%, excess reserves holdings are 65% of deposits, and currency holdings are 45% of deposits. If the Fed buys \$500 million worth of securities, what will be the change in the money supply (measured in dollars)?

Excess reserve ratio (ER) = 65% = 0.65

Currency to deposit ratio (C/D) = 45% = 0.45

Required reserve ratio (RR) = 10% = 0.1

Money multiplier = [1 + (C/D)] / [(C/D) + ER + RR]

Money multiplier = [1 + 0.45] / [0.65 + 0.45 + 0.1]

Money multiplier = (1.45 / 1.20)

Money multiplier = 1.2083

Fed buys \$500 million worth of securities. It will increase the monetary base by \$500 million.

Change in money supply = Money multiplier * Change in monetary base.

=> Change in money supply = 1.2083 * (\$500 million)

=> Change in money supply = \$604.167 million.

Hence, the money supply will increase by \$604.167 million

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