Question

Assume that the banking system has total reserves of $180 billion. Assume also that required reserves are 20 percent of checking deposits and that banks hold no excess reserves and households hold no currency. The new money multiplier is __ , and the money supply is ___ to $ billion.Suppose the Fed raises required reserves to 25

percent of deposits.
The new money multiplier is____ , and the money supply ( increases/ decreases) to____ $billion.

Answer 1

(a) 5; $900 billion

(b) 4; decreases to $720 billion

Step-by-step explanation:

(a) Since the reserve ratio is 20%,

the money multiplier will be:

= 1 ÷ Required reserve ratio

= 1 ÷ 0.2

= 5

Money Supply = Total Reserves × (Money Multiplier)

= 180 × 5

= $900 billion

(b) Since the new reserve ratio is 25%,

the new money multiplier will be:

= 1 ÷ Required reserve ratio

= 1 ÷ 0.25

= 4

New reserves for money supply of $1000 billion = $900 ÷ 4

= $225 billion

Change in reserves = 225 - 180

= $45 billion

New money supply to maintain $45 billion reserves:

= 45 × 4

= $180 Billion

Change in money supply = 900 - 180

= $720 billion