7. The reserve requirement, open market operations, and the moneysupply Assume t

Question

7. The reserve requirement, open market operations, and the moneysupply Assume that banks do not hold excess reserves and that households do not hold currency, so the only form of money is demand deposits. To simplify the analysis, suppose the banking system has total reserves of $300. Determine the money multiplier and the money supply for each reserve requirement listed in the following table. Money Supply (Dollars) Reserve Requirement (Percent) 5 10 Simple Money Multiplier A higher reserve requirement is associated with a money supply. Suppose the Federal Reserve wants to increase the money supply by $200. Again, you can assume that banks do not hold excess reserves and that households do not hold currency. If the reserve requirement is 10%, the Fed will use open-market operations to worth of U.S. government bonds. Now, suppose that, rather than immediately lending out all excess reserves, banks begin holding some excess reserves due to uncertain economic conditions. Specifically, banks increase the percentage of deposits held as reserves from 10% to 25%. This increase in the reserve ratio causes the money multiplier to government bonds in order to increase the money supply by $200 to . Under these conditions, the Fed would need to worth of U.s Which of the following statements help to explain why, in the real world, the Fed cannot precisely control the money supply? Check all that apply. The Fed cannot control the amount of money that households choose to hold as currency. The Fed cannot prevent banks from lending out required reserves. The Fed cannot control whether and to what extent banks hold excess reserves.

Explanation / Answer

1) Simple money multiplier = 1/Reserve requirement = 1/0.05 = 20

Money supply = Reserves x multiplier = 300 billion x 20 = $ 6000 billion

2) Simple money multiplier = 1/Reserve requirement = 1/0.10 = 10

Money supply = Reserves x multiplier = 300 billion x 10 = $ 3000 billion

3) smaller

2) buy

3) $ 20 billion worth of securities

Increase in MS = Multiplier x Reserves

200 billion = 10 x R

R = $ 20 billion

4) decrease

5) 4

Initial multiplier = 1/0.10 = 10

New multiplier = 1/0.25 = 4

6) Buy

7) $ 50 billion woth of US securities

Because 50 x new multiplier = 50 x 4 creates money supply of $ 200 billion.

8) The Fed cannot control the amount of money the households choose to hold as currency.

The Fed cannot control whether and to what extent banks hold excess reserves.

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