Question

If the required reserve ratio is 15 percent, currency in circulation is $400 billion, checkable deposits are $1000 billion, and excess reserves total $1 billion, then the M1 money multiplier is ____

A) 2.35.
B) 2.67
C) 0.551.
D) 2.54

Answer 1

The M1 money multiplier, given a required reserve ratio of 15 percent, is calculated as the inverse of the reserve ratio, which results in 6.67. However, the question includes options that do not match this calculation and might be based on additional assumptions not provided in the question.

Step-by-step explanation:

The question asks us to determine the M1 money multiplier given a required reserve ratio of 15 percent. To calculate the money multiplier, we use the formula 1/reserve ratio. In this case, the reserve ratio is 0.15 (or 15 percent), so the money multiplier is 1/0.15, which equals 6.67. However, since we are interested in the actual increase in the M1 money supply considering the excess reserves, we have to take into account the excess reserves. As the question provides $1 billion in excess reserves, we would also consider any changes in total M1 that this could represent.

In practice, the total change in money supply is not just based on the theoretical multiplier but also on how the excess reserves are used for lending. Given the excess reserves are relatively small compared to the entire checkable deposits, the simple money multiplier calculation should suffice for the purposes of most classroom problems. Therefore, we would use the figure of 6.67 for the M1 money multiplier.