Question

The reserve ratio, open-market operations, and the money supply assume that banks do not hold excess reserves and that households do not hold currency, so the only form of money is demand deposits. to simplify the analysis, suppose the banking system has total reserves of $300. determine the money multiplier and the money supply for each reserve requirement listed in the following table. reserve requirement simple money multiplier money supply (percent) (dollars) 20 10 a higher reserve requirement is associated with a money supply. suppose the bank of canada wants to increase the money supply by $200. again, you can assume that banks do not hold excess reserves and that households do not hold currency. if the reserve requirement is 10%, the bank of canada will use open-market operations to $ worth of canadian government bonds. now, suppose that, rather than immediately lending out all excess reserves, banks begin holding some excess reserves due to uncertain economic conditions. specifically, banks increase the percentage of deposits held as reserves from 10% to 25%. this increase in the reserve ratio causes the money multiplier to to . under these conditions, the bank of canada would need to $ worth of canadian government bonds in order to increase the money supply by $200. which of the following statements help to explain why, in the real world, the bank of canada cannot precisely control the money supply? check all that apply.

a. the bank of canada cannot control the amount of money that households choose to hold as currency.
b. the bank of canada cannot control whether and to what extent banks hold excess reserves.
c. the bank of canada cannot prevent banks from lending out required reserves.

Answer 1

The money supply is calculated using the money multiplier and reserve requirements. The Bank of Canada uses open-market operations to influence money supply, but it is challenged by factors such as households holding currency and banks holding excess reserves that prevent precise control.

Step-by-step explanation:

The student's question involves calculating the money multiplier and the money supply given different reserve requirements, and how a change in the reserve ratio affects these calculations. Additionally, it looks at the practical issues that the Bank of Canada faces in trying to control the money supply through open-market operations.

With total reserves of $300 and a reserve requirement of 20%, the simple money multiplier is 1 divided by the reserve ratio (i.e., 1/0.2 = 5). Subsequently, the money supply would be the product of the total reserves and the money multiplier (i.e., $300 x 5 = $1500). If the reserve requirement is 10%, the money multiplier is 1/0.1 = 10, hence the money supply would be $300 x 10 = $3000.

To increase the money supply by $200 with a 10% reserve ratio, the Bank of Canada would need to purchase $20 worth of government bonds in an open-market operation. However, if banks begin to hold excess reserves, increasing the reserve ratio to 25%, the multiplier would drop, and the central bank would need to purchase more bonds to achieve the same increase in the money supply.

The reasons the Bank of Canada cannot precisely control the money supply are because it cannot control the amount of money households hold as currency, it cannot control the extent to which banks hold excess reserves, and it cannot prevent banks from lending out required reserves.