QUESTION 1: The government of Raiderland uses monetary policy tools similar to t
ID: 1103473 • Letter: Q
Question
QUESTION 1:
The government of Raiderland uses monetary policy tools similar to the Federal Reserve System of the United States and defines its monetary aggregates the same way as the Federal Reserve System of the United States. The required reserve ratio in Raiderland is 10%. The following information also applies to the government of Raiderland:
Bank deposits at the central bank = $200 million
Currency held by the public = $150 million
Currency in bank vaults = $100 million
Checkable bank deposits = $500 million
Traveler’s checks = $10 million
With the information above in mind, answer the following questions:
What is the value of M1?
What is the value of required reserves?
Are commercial banks holding excess reserves? If yes, what is the value of excess reserves?
Can central banks increase checkable deposits? If yes, please explain how, and state by how much checkable deposits can increase.
Explanation / Answer
(a) M1 ($ Million) = Currency held by public + Checkable bank deposits + Travelers check = 150 + 500 + 10 = 660
(b) Required reserves ($ Million) = Checkable deposits x Required reserves ratio = 500 x 10% = 50
(c) Since Total reserves (Currency in Bank vault) > Required reserves, there are excess reserves.
Excess reserves ($ Million) = Total reserves (Currency in Bank vault) - Required reserves = 100 - 50 = 50
(d) Central Banks can increase checkable deposits by engaging in Open market purchase of government securities. The public selling such securities will deposit their cash as bank deposits and checkable deposits will increase.
Maximum increase in checkable deposits ($ Million) = Excess reserves / Required reserves ratio = 50 / 0.1 = 500