12) if the Fed buys $1 million of bonds from the First National Bank, but an add
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12) if the Fed buys $1 million of bonds from the First National Bank, but an additional 10% of any from deposit is held as excess reserves, what is the total Increase in checkable deposits? Use T-accounts to show what happens at cach step of the multiple cxpansion process. s held as excesan 13)the Fed reduces reserves by selling $5 million worth of bonds to the banks, what will the T.account of the banking system look like when the banking system is in equilibrium? What will have happened to the level of checkable deposits? 14) Explain the deterrminants of the money supplyExplanation / Answer
14) Determinants of money supply are:
1. Bank rate: The bank rate is the rate at which the central bank gives credit to the commercial banks. The increase or decrease in the bank rate is often followed by increase or decrease in the market rate of interest. Accordingly, the cost of credit changes the market. During inflation, the cost of capital is increased by increasing the bank rate. This reduces the flow of credit, as desired. On the other hand, during deflation, the cost of capital is reduced by reducing the bank rate. This increases the flow of credit.
2. Open market operation: Open market operation is the sale and purchase of government securities in the open market by the central bank. By selling the securities, the central bank withdraws cash balances from the economy. And, by buying the securities, the central bank adds to cash balances in the economy. During inflation, central bank sells government securities and reduce the money supply and on the other hand, during deflation, central bank buy government securities.
3. Required reserve ratio: It refers to the minimum percentage of a bank's total deposits required to be kept with the central bank. Commercial banks have to keep with the Federal bank a certain percentage of their deposits in the form of cash reserves as a matter of law. When the flow of credit is to be increased, minimum reserve ratio is reduced and vice-versa.
4. Statutory liquidity ratio: Every bank is required to maintain a fixed percentage of its assets in the form of cash or other liquid assets, called SLR. The rate of SLR is fixed by the central bank. To decrease the flow of credit, the central bank increases SLR and vice - versa.
Most powerful or commonly used tool is open market operation.
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