Suppose that currency in cirulation is $600 billion, the amount of checkable dep

Question

Suppose that currency in cirulation is $600 billion, the amount of checkable deposits is $900 billion, and excess reserves are $15 billion.

a.  Calculate the money supply, the currency deposit ratio, the excess reserve ratio, and the money multiplier.

b.  Suppose the central bank conducts an unusually large open market purchase of bonds held by banks of 1400 billion due to a sharp contraction in the economy.  Assuming the ratios you calculated in the part a are the same, what do you predict will be the effect on the money supply.

Explanation / Answer

Solution

A

a.      Money supply = $600 bn + $900 bn = $1500 bn

Currency deposit ratio = 900/600 = 1.5

Excess reserve ratio = 15/1500 = 0.01 =1%

Reserves = 15 + 0.1*900 = $105 bn

Money multiplier = 1/reserve ratio = 1/ {105/900} = 8.57

B

b.      If the ratios are same

By purchase of bonds, the banks release a sum of $1400 billion to the bank

Now, the banks release the sum to open market. The money supply increases by 20 times, i.e 8.57*1400 = $12000 bn

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