6. Assume the following data describe the condition of the banking system: Check

ID: 1209680 • Letter: 6

Question

6. Assume the following data describe the condition of the banking system:

Checking deposits $800B

Cash held by public $200B

Savings/CD deposits $1000B

Credit card balance $200B

Reserve requirement 0.10

a. How large is the M2?

b. How much bank reserve is required in the system?

c. How much M2 will increase if banks lend additional $10B?

d. What will happen to M2 if the Fed raises the short term interest?

e. What will happen to M2 if the Fed buys more bonds?

the money supply would go up because cash would be entering the market.

f. Explain what would happen to the economy is Velocity (V) is significantly increased.

(a) M2 = Checking deposit + Cash held by public + Saving/CD Deposits = $(800 + 200 + 1000)B = $2000B

Note: Credit care balance is not included in M1 or M2.

(b) Required reserve = Checking deposits x Reserve requirement = $800B x 10% = $80B

(d) As short term interest rises, credit lending by banks fall and increase in total money supply falls as well. So, M2 decreases.

Note: First 4 sub-parts are answered.

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