Question

The monetary policy of Namdian is determined by the Namdian Central Bank. The local currency is the dia. Namdian banks collectively hold 100 million dias of required reserves, 25 million dias of excess reserves, 250 million dias of Namdian Treasury Bonds, and their customers hold 1,000 million dias of deposits. Namdians prefer to use only demand deposits and so the money supply consists of demand deposits. Refer to Scenario 29-1. Suppose the Central Bank of Namdia loaned the banks of Namdia 5 million dias. Suppose also that both the reserve requirement and the percentage of deposits held as excess reserves stay the same. By how much would the money supply of Namdia change?

a. 60 million dias

b. 50 million dias

c. 40 million dias

d. None of the above is correct.

Answer 1

Option (C) is correct.

Step-by-step explanation:

Demand deposits = 1000 million dias

Excess reserves = 25 million dias

Percent of demand deposits held as excess reserves = 25%

Therefore,

when 5 million dias are loaned by Central bank, keeping the excess reserves and demand deposits constant,

Banks can create credit = (1 ÷ 25)%

= 4 times or 0.04

Money supply of Namdia change:

= Demand deposits × 0.04

= 1,000 × 0.04

= 40 million dias