Assume that banks do not hold excess reserves and that households deposits. Supp
ID: 1135046 • Letter: A
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Assume that banks do not hold excess reserves and that households deposits. Suppose the banking system has total reserves of $500 billion. Find the simple money multiplier and the money supply for each reserve requirement listed in the following table. do not hold currency-the only form of money is checkable Money Supply (Checkable Deposits) Reserve Requirement 5% 10% Simple Money Multiplier 10 For a given level of reserves, a lower reserve requirement is associated with a money supply. Suppose the Federal Reserve (the Fed) wants to increase the money supply by $500 billion. Again, you can assume that b hold excess reserves and that households do not hold currency. If the reserve requirement is 10%, the Fed will use operations to anks do not worth of U.S. government bonds Now, suppose that rather than immediately lending out all excess reserves, banks begin holding some excess reserves due to uncertain economic conditions. Specifically, in addition to the required reserves of 100 banks hold an additional 40% of their deposits as reserves. This increase in the reserve ratio causes the money multiplier to conditions, the Fed would need to supply by $500 billion. Under these worth of U.S. government bonds in order to increase the moneyExplanation / Answer
Answer 1. For a given level of reserve, a lower reserve requirement is associated with an increase in money supply.
Reason: The money multiplier is calculated using (M) = 1/RR. Where RR is the reserve ratio.
When reserve ratio is 10%, the money multiplier is 10. However, when reserve rratio is 5%, the money multiplier is 20.
Answer 2. Here the reserve requirement is 10%. Therefore, the money multiplier is = 1/10 = 10
The fed will use open-market operations to purchase $55.5 billion worth of US government bonds.
Reason: Purchase of bonds by the government will infuse cash in the banking system. Since 10% is the reserve requirement and money multiplier is 10, the banks need to have $50 billion (after keeping reserve requirements) to increase money supply by $500 billion.
Answer 3. This increase in reserve ratio causes the money multiplier to decline to 2. Under these conditions, the fed would need to purchase $500 billion worth of US government bonds in order to increase the money supply by $500 billion.
Reason: With reserve requirement inceasing to 50%. The money multiplier declines to 2. When the fed purchases bonds worth $500 billion, the cash infusion in banking system is $500 billion. However, $250 billion is kept as reserves. The remaining $250 billion will use the money multiplier of 2 to give $500 billion in money supply increase.
Answer to Multiple Choice: The fed cannot control whether and to what extent banks hold excess reserves.
Example: In the financial crisis of 2008-09, the fed lowered interest rates to near-zero levels and all policies were intended to increase money supply in the system and credit growth. However, the banks did not lend and credit growth declined even after the initiative of policymakers.
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