Suppose the Fed carries out an open market purchase and credits the account of a

Question

Suppose the Fed carries out an open market purchase and credits the account of a bank by $160,000. Further suppose that the common reserve ratio (RR) is 15% even though the fed has set a required reserve ratio of only 10%. By how much is the money supply expected to change if people don't hold onto any currency and instead deposit all of it? $160,000 $640,000 O $800,000 $1,066,666.67 Suppose the Fed carries out an open market purchase and credits the account of a bank by $160,000. Further suppose that the common reserve ratio (RR) is 15% even though the fed has set a required reserve ratio of only 10%. Suppose even further that for every dollar someone has they deposit 80 cents and hold 20 cents in currency. By how much is the money supply expected to change? $160,000 $355,555.55 O $444,444.44 $640,000

Explanation / Answer

1) Since banks are holding 15% of the amount received as deposits the amount of excess reserves are 85%. Hence multiplier for money when currency deposit ratio is zero, is 1/15% = 6.67. Now rise in monetary base is 160,000 and so money supply will increase by 160,000 x 6.67 = 1,066,667

This is the correct choice.

5) Now currency deposit ratio is 20/80 = 1/4 = 0.25. Multiplier now changes to (1 + 0.25)/(0.25 + 0.15) = 3.125. Now rise in monetary base is 160,000 and so money supply will increase by 160,000 x 3.125 = 500,000

This is the correct choice

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