Question

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 Fed would need to $ worth of U.S. government bonds in order to increase the money supply by $200.

Answer 1

The increase in reserve will ultimately lead to an increase in the money supplied.

Step-by-step explanation:

From the scenario under study, the bank is greeted with uncertain economic realities. To cope with this, the bank resolves that rather than lend out excess reserves, it should rather increase the percentage of deposits held as reserve from 10% to 25%. Thus, this leads to a multiplier effect. And the reserve ratio from the forgoing is 1 to 4. That is, 1/10 to 1/4. Meaning there's a reduction in multiplier effecf of 10 to 4. And looking critically, this is a reciprocal of the new reserve ratio of 1/4

When bank hold more reserve, the ripple effect is that the Fed would buy more bonds. To increase the money supply by $200, however, the Fed will need to get a bond of $50.

The implication of this is that the bank reserve will rise in same amount. But taking the multiplier effect into cognizance, a small multiplier will be occasioned in form:

$50 * 4= $200.

Effectively, we have increased the money supply by $200, owing to the multiplier effect.

Answer 2

In order to increase money supply by $200 ,Fed would have to buy U.S government bonds worth of $50

Step-by-step explanation:

Initially:

Reserve requirement = 10% or 0.10

Simple money multiplier = 1/RR = 1/0.10 = 10

Increase in money supply = Increase in total reserves* Simple money multiplier

Increase in money supply is $200

$200=increase in total reserves *10

increase in total reserves=$200/10

=$20

However, since the the the percentage of deposits held as reserves has increased to 25%,the amount Fed would need to invest in U.S government bonds would increase accordingly:

reserve requirement=25% or 0.25

Simple money multiplier =1/IRR=1/0.25=4

crease in money supply = Increase in total reserves* Simple money multiplier

Increase in money supply is $200

$200=increase in total reserves *4

increase in total reserves=$200/4

=$50

Increase in total reserves of $50 implies that Fed has to make $50 to the banks under it by buying U.S government of $50