1 Money Multiplier Suppose the reserve requirement, R¯, is 0.1. a. If the Federa

Question

1 Money Multiplier

Suppose the reserve requirement, R¯, is 0.1.
a. If the Federal reserve prints $323 million worth of paper currency and mails a dollar bill to every resident of the United States, how much will they ultimately increase the money supply?

b. Describe the mechanism by which this increase in the money supply comes about.

c. Suppose half of the banks in the country have a reserve requirement of 0.2 and half have the requirement of 0.1, Then how much will be created, assuming that money alternates between the two types and starts at a R¯ = 0.1 bank.

PS: Please be specific and include all of the work. Thanks

Explanation / Answer

Solution:

According to US Census Bureau, the population of US is $323 million. So when Federal Reserve mails a dollar bill to every resident of U.S, it means the deposits with banks will increase by $323 millions.
Also, federal Reserve prints $ 323 million worth of paper currency. This is distributed to the twelve federal Reserve banks around the country. Each bank maintains an account with one of them
The newly printed paper currency is also circulated in the economy only after being deposited into bank.
So total change in thr reserves or deposits will be $ 323 million + $ 323 million = $ 646 million.

Given Reserve Requirements, R¯ = 0.1
We know Money multiplier = 1/R = 1/0.1 = 1/1/10 = 10
Also Money Supply = Reserve * Money multiplier
where = range
Therefore, Money Supply = $646 million * 10
i.e. Money Supply = $6460 million
Therefore the ultimate increase in money supply will be of $6460 million.

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