Assume that banks do not hold excess reserves and that households do not hold cu
ID: 1204203 • 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 andlysis, suppose the banking system has total reserves of $300. Determine the money multiplier and the money supply for each reserve requirement listed In the following table. A higher reserve requirement is associated with a 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 worthe 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 ronditions. 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 Under these conditions, the Fed would need to worthe of U.S government bonds in order to increase the money supply by $200. 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 prevent banks from lending out required reserves. 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.Explanation / Answer
Reserve Requirement (Percent) Simple Money Multiplier Money Supply (Dollars)
5 20 6000
10 10 3000
Simple Money Multiplier = 1 / Required Reserve Ratio
When Reserve Ratio = 5%
Simple Money Multiplier = 1 /(5 /100) = 1/(1/20) = 20
So the money supply = 20 * $300 (Total Reserves) = $6000
This is because demand deposit is the only form of money.
When Reserve Ratio = 10%
Simple Money Multiplier = 1 /(10 /100) = 1/(1/10) = 10
So the money supply = 10 * $300 (Total Reserves) = $3000
This is because demand deposit is the only form of money.
A higher reserve requirement is associated with a smaller money supply. We can see the effect from the above example as reserve requirement is increased, money supply decreased.
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 $20 worth of U.S. government bonds.
Change in Money Supply = Change in Reserves * Money Multiplier
200 = x * 10
x = 200/10 = 20
So the government have to buy $20 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 25%. This increase in the reserve ratio causes the money multiplier to fall to 4 . Under these conditions, the Fed would need to buy, $50 worth of U.S. government bonds in order to increase the money supply by $200.
When reserve ratio = 25%
Simple Money Multiplier = 1 / Required Reserve Ratio
= 1/(25/100)
= 1/(1/4)
=4
So the money multiplier has decreased.
In order to increase the money supply, Fed had to buy government bonds.
Change in Money Supply = Change in Reserves * Money Multiplier
200 = x * 4
x = 200/4 = $50
So in order to increase the money supply by $200 when money multiplier is 4, the Fed has to buy $50 worth of bonds.
Which of the following statement help to explain why, in the real world, the Fed cannot control the money supply? Check all that apply
The Fed cannot prevent banks from lending out required reserves.
This is false. The Fed can prevent banks from lending out required reserves.
The Fed cannot control the amount of money that households choose to hold as currency.
This is true. 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
This is true. The Fed cannot control whether and to what extent banks hold excess reserves.