The reserve requirement and the money supply Assume that banks do not hold exces
ID: 1200066 • Letter: T
Question
The reserve requirement and the money supply Assume that banks do not hold excess reserves and that households do not hold currency-the only form of money is checkable deposits. Suppose the banking system has total reserves of $600 billion. Find the simple deposit multiplier and the money supply for each reserve requirement listed in the following table. For a given level of reserves, a higher reserve requirement is associated with a_____smaller larger money supply. Suppose the Federal Reserve (the Fed) wants to increase the money supply by $200 billion. Again, you can assume that banks do not hold excess reserves and that households do not hold currency. If the reserve requirement is 20%, the Fed will use open-market operations to_____buy sell_____$100 billion $20 billion $40 billion $5 billion $200 billion worth of U.S. government bonds. Now, suppose that rather than immediately lending out all excess reserves, banks begin holding some excess reserves due to uncertain economic conditions. Specifically, in addition to the required reserves of 20%, banks hold an additional 5% of their deposits as reserves. This increase in the reserve ratio causes the money multiplier to_____fall rise to_____5 4 8 1 2. Under these conditions, the Fed would need to_____buy sell_____$200 billion $40 billion $100 billion $50 billion $25 billion worth of U.S. government bonds in order to increase the money supply by $200 billion. 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. Square The Fed cannot prevent banks from lending out required reserves. Square The Fed cannot control the amount of money that households choose to hold as currency. Square The Fed cannot control whether and to what extent banks hold excess reserves.Explanation / Answer
1.
When RR=10%, then simple deposit multiplier = 1/rr = 1/10% = 10
Money supply required = $600 billion×10 = $6 trillion
2.
When RR=20%, then simple deposit multiplier = 1/rr = 1/20% = 5
Money supply required = $600 billion×5 = $3 trillion
3.
A higher reserve requirement is associated with a smaller money supply.
4.
When RR=20%, then simple deposit multiplier = 1/rr = 1/20% = 5
Money supply required = $200 billion
So, Fed should buy bonds worth $200/5 = $40 billion.
5.
Multiplier to Fall to 1/(20+5) = 1/25% = 4
So, Fed should buy bonds worth $200/4 = $50 billion.
6.
The Fed cannot control the amount of money households choose to hold as currency.