Assume you hold a $10,000 government bond in your safe at home. How much, if any

Question

Assume you hold a $10,000 government bond in your safe at home. How much, if any, of this bond is counted in the determination of the M1 definition of money in the economy?

Assume this bond has fully matured and you decide to convert this bond into currency by redeeming it at a local bank (you sell the bond to the bank and receive the full face value of $10,000 in currency in exchange), if you were to take the currency received in this exchange home and put it in your safe in your closet, what would now be the impact of this exchange on the M1 definition of money in the economy?

If instead of taking the newly received currency home, you elected to deposit this currency into your checking account at the bank, what would now be the impact of this deposit on the M1 definition of money in the economy if that bank elected to hold the entire amount of the deposit as excess reserves in their vault?

If instead of holding the money as excess reserves, assume the bank where you deposited the money and ALL banks within the commercial banking system ALL elect to lend all of their excess reserves, and all borrowers elect to take their newly borrowed funds and deposit these funds into their respective checking accounts at the banks where they each maintain checking accounts, if the required reserve rate for commercial banks was 10% of all checking deposits what would the monetary multiplier calculate to be, and also what would be the extent of the money supply expansion caused by the transactions that would then take place?

Explanation / Answer

CASE I

Government bonds are not counted as part of M1. So, this holding of a $10,000 government bond in the safe at home will not be counted in the determination of the M1 definition of the money in the economy.

CASE II

If bond is redeemed at local bank into currency and this currency is stored at home then this currency will increase the currency in circulation in the economy.

Currency in circulation is counted as part of M1.

So, this receipt of currency in exchange of bond and kept in safe will increase the M1 definition of money in the economy.

CASE III
Currency received by redeeming the bond is deposited in checking account at bank.

Thus, checking account deposits in banking system will increase.

Checking account deposits are counted in M1.

So, this increase in checking account deposits will increase the M1 definition of money in the economy.

CASE IV

Required reserve ratio (rr) = 10% or 0.10

Calculate the monetary multiplier -

Monetary multiplier = 1/Required reserve rate = 1/0.10 = 10

The Monetary Multiplier is 10.

Calculate the extent of money supply expansion -

Expansion in money supply = [Initial deposit - (Initial deposit * rr)] * Monetary multiplier

Expansion in money supply = [$10,000 - ($10,000 * 0.10)] * 10

Expansion in money supply = $90,000

The money supply will expand by $90,000.

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.