Assume that banks do not hold excess reserves and that households do not hold cu
ID: 1124577 • Letter: A
Question
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 $400. Determine the money multiplier and the money supply for each reserve requirement listed in the following table Reserve Requirement (Percent,) 20 10 Money Supply (Dollars) 2,000 4,000 Simple Money Multiplier 10 A higher reserve requirement is associated with a larger money supply Suppose the Federal Reserve 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 Fed will use open-market operations to buy of U.S. government bonds $40.00 worth 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 fall to government bonds in order to increase the money supply by $200 ·Under these conditions, the Fed would need to buy worth of U.S Which of the following statements help to explain why, in the real world, the Fed cannot precisely control the money supply? Check all that apply. The Fed cannot control whether and to what extent banks hold excess reserves The Fed cannot control the amount of money that households choose to hold as currency The Fed cannot prevent banks from lending out required reservesExplanation / Answer
The bank has to hold a portion of its transaction deposit as reserve with the Federal Reserve. The ratio at which it holds its reserve is called required reserve ratio. If the bank reserve at the Fed exceed the required reserve, the reserve over and above requires reserve is excess reserve (ER). Excess reserve does not earn any interest rate and the bank in order to eliminate excess reserve often makes out loans the excess reserve to companies and individuals.
The changes in money supply as the change in the deposit of the bank is determined through the potential deposit multiplier. The potential deposit multiplier is the ratio of potential increase in money supply to the new money injected into the banking system. It is simply the reciprocal of required reserve ratio. It is given as m=1/RR, where RR is required reserve ratio.
The table below gives the money multiplier and potential supply with each reserve requirement
table.
A higher reserve requirement is associated with a __smaller__ money supply.
Suppose the Federal Reserve wants to increase the money supply by $200. If the reserve requirement is 10%, the Fed will use open-market operations to _buy__ $ 20 worth of U.S. government bonds. So that this $20 while deposited can generate $20*10=$200 worth money supply.
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 __fall_ to __4__. Under these conditions, the Fed would need to _buy___(buy/sell) $_100/4=$25___ worth of U.S. government bonds in order to increase the money supply by $100.
The actual deposit multiplier is less than the potential deposit multiplier because of two reasons:
Therefore, the correct options are
The Fed cannot control whether and to what extent banks hold excess reserves.
The Fed cannot control the amount of money that households choose to hold as currency.
Reserve Requirement Simple Money Multiplier Money Supply (Percent) (Dollars) 20 5 2000 10 10 4000