suppose that currency in circulation is $500 billion, the amount of checkable de
ID: 1198986 • Letter: S
Question
suppose that currency in circulation is $500 billion, the amount of checkable deposits is $700 billion, and excess reserves are $12 billion.
a) calculate the money supply, the current deposit ratio, the excess reserve ratio and the money multiplier.
b) suppose the central bank conduct an unusually large open market purchase of bonds held by banks of $800 billion due to a sharp contraction in the economy. Suppose the banks choose to hold all of these proceeds as excess reserves. Assuming that currency and deposits remain the same, what happens to the amount of excess reserves, the excess reserve ratio the money supply and the money multiplier?
Explanation / Answer
(a) Currency in circulation = $500 billion
Checkable deposits = $700 billion
Excess reserves = $12 billion
Required reserves = Checkable deposits - Excess reserves = $700 billion - $12 billion = $688 billion
Required reserve ratio = Required reserves/Checkable deposits = $688 billion/$700 billion = 0.9828 or 98.28%
The required reserve ratio is 98.28%.
Calculate Money Supply -
Money Supply = Currency in circulation + Checkable deposits
= $500 billion + $700 billion
= $1,200 billion
The money supply is $1,200 billion.
Calculate Currency-Deposit ratio -
Currency-Deposit ratio = Currency in circulation/Checkable deposits
= $500 billion/$700 billion
= 0.7142 or 71.42%
The Currency-deposit ratio is 71.42%.
Calculate Excess reserve ratio -
Excess reserve ratio = Excess reserves/Checkable deposits
= $12 billion/$700 billion
= 0.0171 or 1.71%
The excess reserve ratio is 1.71%.
Calculate Money multiplier -
Money Multiplier = 1/Required Reserve ratio = 1/0.98 = 1.01
The Money Multiplier is 1.01.
(b) The central bank has conducted an unusually large open market purchase of bonds worth $800 billion from banks.
It has been stated that banks has choosen to hold these proceeds as excess reserves.
It has been provided that currency and deposits remain same.
As currency and deposit remains same, there would be no change in money supply as money supply is sum total of these two.
So, money supply will remain $1,200 billion.
Since, deposits are also remaining same after this transaction, required reserves will also remain same. This will keep the both required reserve ratio and money multiplier unchanged.
So, money multiplier will remain 1.01.
Calculate new quantity of excess reserves -
New quantity of excess reserves = Present quantity + new additions
= $12 billion + $800 billion
= $812 billion
The new quantity of excess reserves is $812 billion.
Hence, amount of excess reserves has increased from $12 billion to $812 billion due to open market purchase of bonds worth $800 billion by central bank.
Calculate excess reserve ratio -
Excess-reserves ratio = Excess reserves/Checkable deposits
= $812 billion/$700 billion
= 1.16 or 116%
The new excess reserve ratio is 116%.
Hence, the excess reserve ratio has increased from 1.71% to 116% due to open market purchase of bonds worth $800 billion by central bank.
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