Assume that the following data describe the current condition of the commercial

Question

Assume that the following data describe the current condition of the commercial banking system. Value $85 billion $800 bilion $300 bilion 0.10 Total reserves Cash held by public Required reserve ratio a. How large is the money supply (M1)? b. Are the banks fully ublizing their lending capacity? billion in excess reserves. because banks currently have Now assume that the public deposited another $20 bilion in cash in transactions accounts. c. What would happen to the money supply initially (before any lending takes place)? Assuming the $20 billion in cash is not new money in the system, M1 will d. How much would the total lending capacity of the banking system billion be after this portfolio switch? e. How large would the money supply be if the banks fully utlized billion their lending capacity? f. What three steps could the Fed take to offset the potential growth in M1? reserve requirements the discount rate

Explanation / Answer

(a) Money supply = Transaction deposits + Cash held by public = $(800 + 300) billion = $1,100 billion

(b) No, because banks currently have $5 billion in excess reserves.

Required reserves ($ billion) = Transaction deposit x Reserve ratio = 800 x 0.1 = 80

Excess reserves ($ billion) = Total reserves - Required reserves = 85 - 80 = 5

(c) M1 will not change.

(d) Total lending capacity will be $180 billion.

Total increase in loan = $20 billion x (1 - Reserve ratio) / Reserve ratio = $20 billion x (1 - 0.1) / 0.1

= $20 billion x 0.9 / 0.1 = $180 billion

(e) Total money supply will be $1,300 billion.

Increase in money supply = $20 billion / Reserve ratio = $20 billion / 0.1 = $200 billion

New level of money supply = $(1,100 + 200) Billion = $1,300 billion

(f) To offset growth in M1, Fed could:

- Increase reserve requirements

- Increase discount rate

- Sell bonds

Related Questions

Navigate

• Browse (All)
• Browse A
• Subjects

---

---

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