Reserves (R ) = $500 billion Currency ( C) = $400 billion Required Reserves ( RR

Question

Reserves (R ) = $500 billion Currency ( C) = $400 billion Required Reserves ( RR ) = $80 billion Required reserve ratio ( r ) = 0.1 All underlying work must be shown

a.If the excess reserve ratio increases by 0.06, while value of the required reserve ratio and currency to deposits ratio stay the same, what will be the value of the money multiplier? The value of the money supply?

b.If the Fed wishes to have the value of the money supply in the economy at the initial level at part c, how it should respond? Explain

c.How much in government bonds should the Fed sell or buy?

d.If the Fed buys from Chase 10 million in government bonds, given the money multiplier in part f, what would be the change in the money supply?

Explanation / Answer

Reserves (R ) = $500 billion

Currency ( C) = $400 billion

Required Reserves ( RR ) = $80 billion

Required reserve ratio ( r ) = 0.1

With this information, we see that deposits are

80 = 1/0.1 x D

D = 800 billion.

Excess reserves = 500 - 80 = 420 billion. These are 420*100/800 = 52.50% of deposits or ER-D ratio = 0.5250

RR-D ratio = 0.10

C-D ratio = 400/800 = 0.50

Money supply = C + D = 1200. Monetary base = C + RR = 480

a.If the excess reserve ratio increases by 0.06, while value of the required reserve ratio and currency to deposits ratio stay the same, what will be the value of the money multiplier? The value of the money supply?

ER-D ratio is now 0.5256. Multiplier becomes mm = (1 + 0.50)/(0.5256 + 0.10 + 0.50) = 1.33

Money supply will increase by mm x increase in monetary base

= 1.33 x (0.06 x 800) = 63.84 billion

b.If the Fed wishes to have the value of the money supply in the economy at the initial level at part c, how it should respond?

Initial money supply is C + D = 1200. New money supply is increased by 63.84 billion where excess reserves are increased by 0.06 x 800 = 48 billion. Fed should use open market operations and reduce money supply by selling government bonds.

c.How much in government bonds should the Fed sell or buy?

Fed is willing to reduce Monetary base by 48 so that new money supply is 1.33 x 48 = 63.84 billion

d.If the Fed buys from Chase 10 million in government bonds, given the money multiplier in part f, what would be the change in the money supply?

Multiplier is 1.33. If monetary base is increased by 10 million, money supply increases by 10 x 1.33 = 13.3 million

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