help in homework

New User?

Fill This Form To Receive Instant Help

Help in Homework
trustpilot ratings
google ratings


Homework answers / question archive / 1) This section deals with increase money supply given two scenarios (see “a” and “b” below)

1) This section deals with increase money supply given two scenarios (see “a” and “b” below)

Communications

1) This section deals with increase money supply given two scenarios (see “a” and “b” below). In Westlandia, the public holds 50% of money one (M1) in the form of currency, and the required reserve ratio is 20%. a) Estimate how much the money supply will increase in response to a new cash deposit of $500 by completing the accompanying table.   (Hint: The first row shows that the bank must hold $100 in minimum reserves — 20% of the $500 deposit — against this deposit, leaving $400 in excess reserves that can be loaned out. However, since the public wants to hold 50% of the loan in currency, only $400 × 0.5 = $200 of the loan will be deposited in round 2 from the loan granted in Round 1.)
Round Deposits
Required reserves
Excess reserves Loans
Loan proceeds held as currency
Loan proceeds deposited
1 $500.00 $100.00 $400.00 $400.00 $200.00 $200.00
2 $200.00          
3            
4            
5            
6            
7            
8            
9            
10            
             
Totals            
b) How does your answer compare to an economy in which the total amount of the loan is deposited in the banking system and the public does not hold any of the loans in currency? (Hint: Complete the table below when none of the loan proceeds held in currency following the example for row 1.)
Round Deposits
Required reserves
Excess reserves Loans
Loan proceeds held as currency
Loan proceeds deposited
1 $500.00 $100.00 $400.00 $400.00 0.00 $400.00
2 $400.00          
3            
4            
5            
6            
7            
8            
9            
10            
             
Totals            
c) What does this imply about the relationship between the public’s desire for holding currency and the money multiplier? Which scenario will contribute more to increase in money supply?  
2) Explain how each of the following changes quantity of money (money supply) in the economy.
a. the Fed buys bonds
b. the Fed auctions credit
c. the Fed raises the discount rate
d. the Fed raises the reserve requirement
 

pur-new-sol

Purchase A New Answer

Custom new solution created by our subject matter experts

GET A QUOTE

Answer Preview

Answer:

Note: As the question says, total increase in money supply is computed after 10 rounds of lending process and not ad infinitum.

(1)

(a)

Round Deposits Required Reserves Excess Reserves Loan Loan Held as currency Loan proceeds deposited
1 500 100 400 400 200 200
2 200 40 160 160 80 80
3 80 16 64 64 32 32
4 32 6.4 25.6 25.6 12.8 12.8
5 12.80 2.56 10.24 10.24 5.12 5.12
6 5.12 1.02 4.10 4.10 2.05 2.05
7 2.05 0.41 1.64 1.64 0.82 0.82
8 0.82 0.16 0.66 0.66 0.33 0.33
9 0.33 0.07 0.26 0.26 0.13 0.13
10 0.13 0.03 0.10 0.10 0.05 0.05
TOTAL 833.25 166.65 666.60 666.60 333.30 333.30

So, total increase in money supply (after 10 rounds) = Increase in loans = $600

(b)

Round Deposits Required Reserves Excess Reserves Loan Loan Held as currency Loan proceeds deposited
1 500 100 400 400 0 400
2 400 80 320 320 0 320
3 320 64 256 256 0 256
4 256 51.2 204.8 204.8 0 204.8
5 204.80 40.96 163.84 163.84 0 163.84
6 163.84 32.77 131.07 131.07 0 131.07
7 131.07 26.21 104.86 104.86 0 104.86
8 104.86 20.97 83.89 83.89 0 83.89
9 83.89 16.78 67.11 67.11 0 67.11
10 67.11 13.42 53.69 53.69 0 53.69
TOTAL 2231.56 446.31 1785.25 1785.25 0 1785.25

So, total increase in money supply (after 10 rounds) = Increase in loans = $1785.25

(c)

Therefore, as the public desires to hold more currency, money multiplier decreases. Scenario (b) contributes more toward creation of money supply.

(2)

(a) When Fed buys bonds in exchange of cash, amount of cash at hands of public increases, in other words, money supply increases.

(b) The Fed auctions credit using the Term Auction Facility (TAF) using which, the Fed auctions specified amount of collateral-backed short term securities to financial institutions at a rate lower than discount rate. Since TAF is designed to create more liquidity, it increases money supply.

(c) When Fed raises discount rate, it becomes costlier for commercial banks to borrow money from Fed, and they raise their own lending rates. This decreases new credit and money supply decreases.

(d) A higher reserve requirement will compel commercial banks to set aside a higer portion from new deposits as required reserves, not available for commercial lending purposes. This will reduce new lending and money supply will reduce.

Sitejabber (5.0)

BBC (5.0)

Trustpilot (4.9)

Google (5.0)

Related Questions