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

Question

Assume that the following data describe the condition of the commercial banking system: Total Reserve: $80 billion Transaction deposits: $700 billion Cash held by public: $300 billion Reserve required: 0.10 a) How large is the money supply (M1)? b. Are the banks fully utilizing their lending capacity? Explain. c. What would happen to the money supply initially if the public deposited another $20 billion in cash in transactions accounts? Explain. d. What would the lending capacity of the banking system be after such a portfolio switch? e. How large would the money supply be if the banks fully utilized their lending capacity? f. What three steps could the Fed take to offset the potential growth in M1?

Explanation / Answer

A) The monet supply measure M1 has two components: Deposits and Currency held by the public. Hence, the money supply is $1000 billion ($700 billion + $300 billion)

B) There are no excess reserves so the banks must have advanved the same in the form of loans. Hence bank must be using its lending capaicity to the fullest.

C) If people deposit $20 billion they held in cash, in their account, then the sum of currency and deposit will not change. Hence money supply M1 will remain the same.

D) Banksare not holding excess reserves as of now. When deposits are increased by $20 billion, $2 billion are kept as reserved. After such a portfolio switch, bank has excess reserves of $18 billion, so the lending capacity rises.

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