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O ezto.mheducation.com/hm.tpx?todo-postSubmissionView Alma's Accounting a Taxes To Go H TimeClockCalCareers D Total reserves Transactions deposits Cash held by public Required reserve ratio Value $85 billion $800 billion $300 billion 0.10 a. How large is the money supply (M1)? 00billion b. Are the banks fully utilizing their lending capacity? Nobecause banks currently have billion in 5 excess reserves ow assume that the public deposited another $20 billion in cash in transactions accounts c What would happen to the money supply initially (before any lending takes place)? Assuming the s20 billion in cash is not new money in the system. not change M1 will d. How much would the total.lending capacity of the banking 30 billion system be after this portfolio switch? utilized their lending capacity? f What three steps could the Fed take to offset the potential growth in M12 e. How large wouid the money supply be if the banks fully 330 illio S 330 billion

Explanation / Answer

Ans (a) M1 = Currency + Demand deposits = $1100 billion

(b) Required Reserves = 10% of 800 = $80 billion but bank is keeping $85 billion, so excess is $5 billion

(c) Not change because it is old money and not new money in the system. Old money is already accounted in M1

(d) Initial banking reserve = $800 billion

Then public deposited another $20 billion in the banks.

Now total reserve in banks = $820 biillion . Required reserve ratio = 10%

So, Required reserve = 10% of $820 billion = $82 billion.

So, the bank can lend the $738 billion to the public from its reserves (= $820-$82)

(e) Money supply = (1/rr) Monetary Base

(1/0.10) $820 = $8200 billion

(f) To offset the increase in M1, Fed uses contractionary monetary policy

(i) It can raise the required reserve ratio so that bank would be able to lend less to the public.

(ii) It can raise the discount rate so that bank would borrow from the Fed at higher interest rate. As a result, bank would charge high interest rates from customers. Because of high interest rate, borrowers will borrow less.

(iii) Fed can raise cash reserve ratio which is the minimum amount that bank needs to maintaint with the central bank.

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