Consider a world in which there is no currency and depository institutions issue

Question

Consider a world in which there is no currency and depository institutions issue only checkable deposits and desire to hold no excess reserves. The required reserve ratio is 20 percent. The central bank sells $1 billion in government securities. What happens to the money supply? Give reasons to support your answer. Some economists argue in favor of abolishing the government-sponsored deposit insurance. Do you agree or disagree with this argument? Write a well-reasoned argument defending your stance. If deposit insurance were abolished, explain how would this change the incentive structure facing depository institutions?

Explanation / Answer

It will function as usual. It is great for the banks that it will be no leak in cash.The money multiplier=1/0.20=5.The money supply will increase=5x1=5 in $ and billion.

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