Topics of the Fed a. Assume money supply (M) is $1200 billion, total bank deposi

Question

Topics of the Fed a. Assume money supply (M) is $1200 billion, total bank deposits (D) are $800 billion and the required reserve ratio is 10%. What would the Fed have to do to lower the money supply by 5%? Explain your answer. (Hint you do not need the currency ratio (cu) or the reserve ratio (re) in order to complete this problem.) b. Assume that an increasing number of department and grocery stores accept credit cards and more consumers use these cards to do their shopping. How will the money multiplier and money supply be affected?

Explanation / Answer

a. Assume money supply (M) is $1200 billion, total bank deposits (D) are $800 billion and the required reserve ratio is 10%. What would the Fed have to do to lower the money supply by 5%?

M = 1200. Deposits = 800. RR = 10%. Money supply M = C + D. 1200 = C + 800. Currency = 1200 - 800 = $400 billion. C-D ratio = 50%, RR-D ratio = 10%. Multiplier = (1+50%)/(50%+10%) = 2.5

New money supply = 1200 - 5% x 1200 = 1140. Redcution in money supply = 60 billion

Required reduction in reserves = 60/2.5 = 24 billion

Fed should reduce monetary base by 24 billion

b. Assume that an increasing number of department and grocery stores accept credit cards and more consumers use these cards to do their shopping. Credit cards will reduce circulated money and so Currency deposit ratio will fall. This will reduce the money supply in the economy because value of multiplier is now smaller.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

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