My MS was 1500 bil, C.667 ER: .0167, rr .15, and m 1.99952) 1a.. Suppose the cen

Question

My MS was 1500 bil, C.667 ER: .0167, rr .15, and m 1.99952)

1a.. Suppose the central bank conducts an open market purchase of bonds held by banks of $140 billion. Assuming the ratios you calculated in part a remain unchanged, what will be the magnitude and driection of the effect on the money supply?

b. Now suppose the central bank conducts the same open market purchase as in part b, except that banks choose to hold all of these proceeds as excess reserves rather than loan them out, due to fear of a financial crisis. Assuming that currency and deposits remain the same, what happens to the amount of excess reserves, the excess reserve ratio, the money supply, and the money multiplier.

Explanation / Answer

m= (1+c)/(c+rr+er) =(1+.667)/(.667+.15+.0167)= 1.99952

ans 1 a)

if central bank conducts an open market purchase of bons of $140 billions than it leads to total money creation = m*140 =1.99952*140= $279.9328 billion

so money supply will increase by magnitude of $279.9328 billion

ans b) in first part we assumed that what bank recieve from central bank will be used by bank to give loans that would lead to credit creation and money creation

now in 2nd part , bank is holding $140 billion as excess reserve. this would lead to increase in excess reseves by $140 billion.

excess reserve= er*( deposit)

where er is excess reserve ratio.

as it is given that deposit are same, but excess reserves have increased that will be due to increase in excess reserve ratio , er

when er increases and it is in the denominator in the formula for money multiplier m= (1+c)/(c+rr+er), so money multiplier will decrease and so the money supply

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