(1) Money Definitions. To answer the following questions, refer to the money def

Question

(1) Money Definitions. To answer the following questions, refer to the money definitions and relationships 1: Total currency = (currency in circulation) + (vault cash) 2. Total reserves = (vault cash) + (reserve deposits) 3. Monetary Base (MB) = (currency in circulation) + (total reserves) 4. M1 = (currency in circulation) + (demand deposits) 5. M2 = M1 + (savings deposits) + (small time deposits) + (retail money market accounts) For each question, assume that the information given in the previous question still holds.

a. Suppose there is $100 worth of total currency, 10% of which is held in the vaults of banks. How much currency is in circulation?

b. Suppose that banks have a total of $400 worth of reserve deposits at the Fed. What is the value of the monetary base?

c. Suppose the public initially has a total of $100 deposited in checking accounts (demand deposits). If the public withdraws $10 in cash from their checking accounts, how would the M1 money supply and the monetary base be affected?

Explanation / Answer

(a)

Total currency = $100

Vault cash = 10% x $100 = $10

So, currency in circulation = $100 - $10 = $90

(b)

Total Reserves = Vault cash + Reserve deposits

= $10 + $400 = $410

So, monetary base = Currency in circulation + Total reserves

= $90 + $410 = $500

(c)

Original M1 = Currency in circulation + Demand Deposits

= $90 + $100 = $190

If demand deposits decrease by $10, it will not affect moentary base since it's not a component of monetary base.

But M1 will decrease by $10 & new value of M1 will be $180.

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