1 Money Multiplier Suppose the reserve requirement, R, is 0.1. 1. If the Federal

Question

1 Money Multiplier Suppose the reserve requirement, R, is 0.1. 1. If the Federal reserve prints $323 million worth of paper currency and mails a dollar bill to every resident of the United States, how much will they ultimately increase the money supply? 2. Describe the mechanism by which this increase in the money supply comes about 3. Suppose half of the banks in the country have a reserve requirement of 0.2 and half have the requirement of 0.1, Then how much will be created, assuming that money alternates between the two types and starts at a R=0.1 bank.

Explanation / Answer

1) The money supply increases by = 323 * multiplier .

multiplier = 1/ required reserve ratio

multiplier = 1/0.1 = 10

so, the ultimate money supply can be increase = 323 * 10 = 3230

money supply increase by $3230 million .

2) The mechanism of increase in the money supply is the multiplier. it is the multiplier who tell the how much the increase in the money supply with the intial deposit of money and multiplier is the reciporocal of the required reserve ratio ,

3) we just find avergae required reserve ratio = 0.2 +0.1 = 0.3 /2 = 0.15

so multiplier = 1/0.15 = 6.7

so money supply increases to = 323*6.7 = $2164.1 million.

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