Question

Suppose that currency in circulation is $600 billion, the amount of checkable deposits is $900 billion, and excess reserves are $15 billion.

a. Calculate the money supply, the currency deposit ratio, the excess reserve ratio, and the money multiplier.

b. Suppose the central bank conducts an unusually large open market purchase of bonds held by banks of $1400 billion due to a sharp contraction in the economy. Assuming the ratios you calculated in part a are the same, what do you predict will be the effect on the money supply?

c. Suppose the central bank conducts the same open market purchase as in part b, except that banks choose to hold all of these proceeds as excess reserves rather than loan them out, due to fear of a financial crisis. Assuming that currency and deposits remain the same, what happens to the amount of excess reserves, the excess reserve ratio, the money supply, and the money multiplier?

Answer 1

The money supply, currency deposit ratio, excess reserve ratio, and money multiplier can be calculated based on the given information. An unusually large open market purchase of bonds will affect the money supply based on the money multiplier. If banks choose to hold the proceeds as excess reserves, it will impact the excess reserve ratio and money supply.

Step-by-step explanation:

The questions can be answered as -

a. To calculate the money supply, we add the currency in circulation and the checkable deposits: $600 billion + $900 billion = $1500 billion. To calculate the currency deposit ratio, we divide the currency in circulation by the checkable deposits: $600 billion / $900 billion = 0.667. To calculate the excess reserve ratio, we divide the excess reserves by the checkable deposits: $15 billion / $900 billion = 0.0167. To calculate the money multiplier, we use the formula 1 / reserve ratio, so 1 / 0.0167 = 59.88.

b. An unusually large open market purchase of $1400 billion will increase the excess reserves. Assuming the ratios remain the same, the money supply will increase by the money multiplier (59.88) times the increase in excess reserves.

c. If banks choose to hold all the proceeds as excess reserves, the amount of excess reserves will increase by $1400 billion. The excess reserve ratio will increase, and the money supply will decrease by the money multiplier (59.88) times the decrease in excess reserves.