1. Suppose the Fed decides to stimulate the economy. Assume there is no cash lea

Question

1.Suppose the Fed decides to stimulate the economy. Assume there is no cash leakage and required reserve ratio is 25% now, and banks have no excess reserves.

A. Show how the Fed would increase M1 by 1 million dollars by changing the reserve ratio.

Suppose the Fed decides to stimulate the economy. Assume there is no cash leakage and required reserve ratio is 25% now, and banks have no excess reserves. Show how the Fed would increase M1 by 1 million dollars by changing the reserve ratio. Show how the Fed would increase M1 by 1 million dollars through open market operation.%u2028

Explanation / Answer

1. Lower the reserve ratio so the banking system had approximately 250,000 in excess reserves (actually you wouldn't have to do it by quite 250,000 because the money multiplier would slightly increase). So 250,000 /.25= 1,000,000 and the banking system could create 1,000,000 of new money.

2. Buy 250,000 of bonds through open market operations. This would add 250,000 to bank reserves. The banking system could expand this by 1/.25 *250,000= 1,000,000.

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