*3 In problem 1, suppose that the Bank of Nocoin, the central bank, undertakes a
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Question
*3 In problem 1, suppose that the Bank of Nocoin, the central bank, undertakes an open market purchase of bonds of 1 billion. a What happens to the monetary base? b What happens to the reserves of the banks? ank lending, what change in the quantity of loans, deposits, reserves and currency in circulation? d After two rounds of bank lending, what is the cha cernthy n smsy ot hans deois rserves e When excess reserves are zero, what is the change in the quantity of loans, deposits, reserves and cur- rency in circulation? f What is the magnitude of the money multiplier in Nocoin?
Explanation / Answer
3) a) Monetary base is the total amount of money in the hand of public and amount deposited by commercial bank as the reserve in the central bank. Here, reserves deposited with bank of Nocoin is 10 billion and 30 billion in the hands of public. So, total monetary base is 40 billion.
Now, bank of Nocoin bought bond worth 1 billion, this transaction of central bank would reduce the monetary base by 1 billion.
b) Reserves of the banks also decrease to 14 billion due to fall in reserve with central bank.
c) After first round of bank lending,
quantity of loan was same as before.
Bank reserves are the holding of deposits in account with central bank. So, deposits with commercial bank fall due to fall in reserves.
Total reserves also falls by 1 billion
currency in circulation does not change as quanity of loan was same.
d) After second round of lending,
with the fall in monetary base, quantity of loan decreases and with fall in quantity of loan amount currency in circulation also decrease.
Money supply fall with fall in monetary base. With fall in money supply, interest rate increase as interest rate increases, demand deposit in bank increases and with rise in demand deposits, reserves also increases.
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