Suppose that currency in circulation is $500 billion, the amount of checkable de

Question

Suppose that currency in circulation is $500 billion, the amount of checkable deposits is $1,000 billion, excess reserves are $150 billion, and the required reserve ratio on checkable deposits is 10%.

Calculate the money supply, the monetary base, the currency deposit ratio, the excess reserve ratio, and the money multiplier.

Suppose the central bank conducts a large open market purchase of bonds held by banks of $250 billion due to a sharp contraction in the economy. Assuming the ratios you calculated in part a are the same, what do you predict will be the effect on the money supply?

Suppose the central bank conducts the same open market purchase as in part b, except that banks choose to hold all of these proceeds as excess reserves rather than loan them out, due to fear of a financial crisis. Assuming that currency and deposits remain the same, what happens to the amount of excess reserves, the excess reserve ratio, the money supply, the monetary base, and the money multiplier?

Explanation / Answer

Currency C= $500 billion

Checkable deposits D= $1000 billion

Excess reserves ER= $150 billion

RR = 10%

a) Money Supply M= 500+1000 = $1500 billion

Monetary base MB= 500+150 +0.1*1000= $750 billion

C/D ratio = 0.5

Money multiplier MM = M/MB = 2

Excess reserve ratio ER/D = 0.15

b) C will increase by $250 billion = $750 billion Now M = $1750 Billion

c) Now as per the condition stated C will remain $500 but ER will increase to $400 billiom

Money Supply M= 500+1000 = $1500 billion

Monetary base MB= 500+400 +0.1*1000= $1000 billion

C/D ratio = 0.5

Money multiplier MM = M/MB = 0.67

Excess reserve ratio ER/D = 0.4

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