Explain completely the mechanism through which a change in the following will ch
ID: 1203351 • Letter: E
Question
Explain completely the mechanism through which a change in the following will change the money supply, M1.
A) an increase in c
B) an increase in rd
C) a decrease in e
D) an increase in the federal funds rate
refer to following: M1 = (m) * [MB] = m * (MBn + BR)
where
m = [(1 + c)/(rd + c + e)]
and MB = MBn + BR
where MB = Monetary base = C + R
C = Currency in Circulation
R = Bank Reserves
MBn = Non-borrowed Monetary Base
BR = Borrowed Reserves = Borrowed Reserves from the Federal Reserve System
m = money multiplier
c = C/D = currency ratio
rd = required reserve ratio against deposits
e = ER/D = Bank precautionary reserve ratio
Explanation / Answer
A. The money stock is negatively related to c because rise in C / DD ratio will bring about a shift from deposit to currency and since deposits undergo multiple expansion while currency does not, the net result is contraction of money multiplier and money supply.
B and C-
Enhancement of reserve ratio or rise in the bank's holding of excess reserves leaves less reserves free to support bank deposits, thus leading to monetary contraction.
D:
This will drain reserves from banking and lead to decline in excess reserves and increase in required reserves, thus negatively impacting money supply