Question

Suppose there is $24 million of cash in existence with 2/3 of it held in bank vaults as reserves. If the required reserve to checking deposit ratio is 20%, how large will the money supply be if banks hold no excess reserves?

Answer 1

To determine the change in the money supply, calculate the required reserves and deduct them from the total cash in existence. The remaining amount is the money supply.

Step-by-step explanation:

To determine the change in the money supply, we need to understand the concept of required reserves and excess reserves. Required reserves are the amount of money that banks must hold in reserves according to the reserve requirement set by the Federal Reserve. Excess reserves, on the other hand, are any reserves held by banks in addition to the required reserves. In this scenario, we are told that 2/3 of the $24 million cash in existence is held in bank vaults as reserves.

Given that the required reserve to checking deposit ratio is 20%, we can calculate the required reserves by multiplying the total checking deposits by the reserve ratio. The remaining amount after deducting the required reserves from the total cash in existence will be the money supply. Since banks are holding no excess reserves, the required reserves will be two-thirds of the cash in existence, which is $16 million. Therefore, the money supply will be the remaining one-third of the cash in existence, which is $8 million.