7. Suppose that the reserve requirement for checking deposits is 10 percent and

Question

7. Suppose that the reserve requirement for checking deposits is 10 percent and that any excess reserves. a. if the Fed sells $1 million of government bonds, what is the effect on the economy's reserves and money supply? Answer b. Now suppose the Fed lowers the reserve requirement to 5 percent, but banks choose to hold another 5 percent of deposits as excess reserves. Why might banks do so? What is the overall change in the money multiplier and the money supply as a result of these actions Answer

Explanation / Answer

7) a) since the reserve requirement ratio is 10% and there are no excess reserves.

The money multiplier= 1/reserve requirement ratio

=1/0.10

=10

now if fed sells $1 million of govenment bonds , the reserves will reduce by $1 million and the money supply will reduce by $1*10 i.e. $10million

b) If banks choose to hold 5% of deposit as excess reserve and reserve requiremnt ratio is 5% , the total reserve will be 10% which is same as earlier, the might hold excess reserve in order to manage daily operations.

Hence there will be no chage in money multiplier and money supply by taking these actions.

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