Question

Answer the questions on the money multiplier based on the following information: Suppose that the required reserve ratio is 10%, currency in circulation is $600 billion, the amount of checkable deposits is $950 billion, and excess reserves is $20 billion. a) The money supply is ____________ billion. b) The currency deposit ratio is _____________. c) The excess reserves ratio is ____________. d) The money multiplier is ____________. e) Suppose the central bank conducts a large open market purchase of bonds held by banks in the amount of $1,400 billion. Assuming the previous ratios calculated are the same, the money supply should _______________ to $_________________ billion. f) Briefly explain what would happen to the money supply if the banks chose to hold these proceeds in excess reserves rather than loan them out.

Answer 1

A - Money supply = 600+950

= $ 1550 billion

B - Cash deposit ratio = 600/950

= 0.63

C - Excess reserve ratio = 20/950

= 0.021

Or 2.1 percent

D - Money multiplier = 1/ reserve ratio

= 1/0.10

= 10

E - Money supply should increase.

Total increase in money supply = 1400*10

= $ 14000 billion

2 - If the banks will choose to hold more reserves , the reserve ratio will increase. As the result the money multiplier will fall and there will be lesser increase in the money supply or the money supply will decrease in the economy