Assume that banks do not hold excess reserves and that households do not hold cu
ID: 1200256 • 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 checkable deposits. To simplify the analysis, suppose the banking system has total reserves of $100. Determine the simple deposit multiplier and the money supply for each reserve requirement listed in the following table. A lower reserve requirement is associated with a_____money supply. Suppose the Federal Reserve wants to increase the money supply by $100. 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_____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, banks increase the percentage of deposits held as reserves from 10% to 20%. This increase in the reserve ratio causes the 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 $100. 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 the amount of money that households choose to hold as currency. The Fed cannot control whether and to what extent banks hold excess reserves. The Fed cannot prevent banks from lending out required reserves.Explanation / Answer
Ans.
Ans.
Multiplier = 1/reserve requirement.
1. Multiplier = 1/15% = 100/15 = 6.67
Money supply = multiplier*initial deposit (reserves)
Money supply = 6.67*100 = $667.
2. Multiplier = 1/10% = 100/10 = 10.
Money supply = 10*100 = $1000.
3. Higher. (inverse relation between reserve requirenment and money supply)
4. Buy.
Buying bonds from the open market operation would mean infusing money into the economy.
5. As per the equation, 100 = 1/10%*initial deposit.
100 = 100/10*initial deposit
100 = 10*initial deposit
initial deposit = $10.
Thus the government needs to buy $10 worth of bonds as they will increase the money supply by $100 with reserve requirement of 10%.
The correct option is:
The fed cannot control the currency that households chooses to hold it as currency.