Explain completely the mechanism through which a change in the following will ch

Question

Explain completely the mechanism through which a change in the following will change the money supply, M1.

A) an increase in c

B) an increase in rd

C) a decrease in e

D) an increase in the federal funds rate

refer to following: M1 = (m) * [MB] = m * (MBn + BR)

where

m = [(1 + c)/(rd + c + e)]

and MB = MBn + BR

where MB = Monetary base = C + R

C = Currency in Circulation

R = Bank Reserves

MBn = Non-borrowed Monetary Base

BR = Borrowed Reserves = Borrowed Reserves from the Federal Reserve System

m = money multiplier

c = C/D = currency ratio

rd = required reserve ratio against deposits

e = ER/D = Bank precautionary reserve ratio

Explanation / Answer

A. The money stock is negatively related to c because rise in C / DD ratio will bring about a shift from deposit to currency and since deposits undergo multiple expansion while currency does not, the net result is contraction of money multiplier and money supply.

B and C-

Enhancement of reserve ratio or rise in the bank's holding of excess reserves leaves less reserves free to support bank deposits, thus leading to monetary contraction.

D:

This will drain reserves from banking and lead to decline in excess reserves and increase in required reserves, thus negatively impacting money supply

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