Assume that the consolidated balance sheet for the commercial banking system can

Question

Assume that the consolidated balance sheet for the commercial banking system can be simplified as follows: D+NW=R+L where D=deposits, NW= net worth, R=reserves and L=loans. Assume that the bans maintain a fixed reserves ratio (R/D) of 10% and a capital adequacy ratio (NW/L) of 10%. In addition, assume that the cash holdings of the non-bank public remain close to 5% remain close to 5% of deposits and that reserves total $20bn.

a) how large is the monetary base ($bn)?

b)how large is the (broad) money supply?

c) what is the value of the money multiplier?

d) how is the money multiplier related to the reserves ratio?

Explanation / Answer

a.

Monetary base = Reserves + currency in circulation

Currency in circulation = 5% of the deposits

Deposits = Reserves / RR = 20 Billion / .1 = 200 Billion

Thus,

Monetary base = 20 Billion + 5% of 200 Billion = 20 Billion + 10 Billion = 30 Billion

c.

Money Multiplier = 1/RR = 1/10% = 10

b.

Money Supply = currency in circulation + Deposits *money multiplier

Money Supply= 10 Billion + 200 Billion*10 = 2010 Billion

d.

Money multiplier is inversely proportional to reserve ratio.

Money Multiplier = 1/RR

Thus, higher value of Reserve ratio will decrease the value of money multiplier.

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