1. Suppose banks do not hold excess reserves and the public does not hold cash.

Question

1. Suppose banks do not hold excess reserves and the public does not hold cash. For each of the following monetary policies, compute the change in money supply. Show your steps and explain.

a. The Fed makes $3000 open market purchase. The required reserve ratio is 20%.

b. The Fed calls in $500 discount loans and the required reserve ratio is 10%.

c. The Fed sells $200 worth of bonds to banks. The required reserve ratio is 50%.

d. The Fed lowers the required reserve ratio from 10% to 1%. There are $5 million in bank reserves.

Explanation / Answer

(a) Open market purchase will increase money supply.

Increase in money supply ($) = Open market purchase / Required reserve ratio = 3,000 / 0.2 = 15,000

(b) Calling in of discount loans will decrease money supply.

Decrease in money supply ($) = Loan called in / Required reserve ratio = 500 / 0.1 = 5,000

(c) Selling bonds will decrease money supply.

Decrease in money supply ($) = Amount of bonds sold / Required reserve ratio = 200 / 0.5 = 400

(d) Lowering of required reserve ratio will increase money supply.

When Required reserve ratio = 10%, Money supply ($ Million) = 5 / 0.1 = 50

When Required reserve ratio = 1%, Money supply ($ Million) = 5 / 0.01 = 500

Increase in money supply ($ Million) = 500 - 50 = 450

Related Questions

Navigate

• Browse (All)
• Browse 1
• Subjects

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