Question

Suppose that currency in circulation is $600 billion, the amount of checkable deposits is $900 billion, and holding of excess reserves are $15 billion. r-d=.10

a. Calculate the money supply(M1+), the currency deposit ratio, the excess reserve ratio, and the money multiplier. You must show all of your work

Answer 1

The money supply (M1) equals $1.5 trillion, the currency deposit ratio is 2/3, the excess reserve ratio is 1/60, and the money multiplier is approximately 1.28. Deposits into demand accounts increase the M1 money supply because these are checkable and act as a medium of exchange.

Step-by-step explanation:

The question asks for the calculation of money supply (M1+), the currency deposit ratio, the excess reserve ratio, and the money multiplier. Starting with the money supply (M1), it includes currency in circulation and checkable deposits. Thus, M1 = Currency in Circulation + Checkable Deposits = $600 billion + $900 billion = $1.5 trillion.

The currency deposit ratio is the amount of currency individuals hold compared to the amount they hold in checkable deposits. The currency deposit ratio (c/d) = Currency in Circulation / Checkable Deposits = $600 billion / $900 billion = 2/3.

The excess reserve ratio (ER) is the fraction of the total checkable deposits that banks hold as excess reserves. ER = Excess Reserves / Checkable Deposits = $15 billion / $900 billion = 1/60.

To find the money multiplier (m), we can use the formula m = 1 / (r-d + ER + c/d), where r-d represents the required reserve ratio (which is given as 0.10 or 10%). Plugging in our numbers, we get m = 1 / (0.10 + 1/60 + 2/3) = 1 / (0.11666 + 0.66667) = 1 / 0.78333 ≈ 1.28. Thus, the money multiplier is approximately 1.28.

Making loans that are deposited into a demand deposit account increases the M1 money supply. This is because M1 includes checkable (demand) deposits, which can be used as a medium of exchange for goods and services.