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Suppose that the required reserve ratio is 10%, currency in circulation is $400 billion, the amount of checkable deposits is $700 billion, and excess reserves are $50 billion
- Suppose that the required reserve ratio is 10%, currency in circulation is $400 billion, the amount of checkable deposits is $700 billion, and excess reserves are $50 billion.
- Calculate the money supply, the currency deposit ratio, the excess reserve ratio, and the money multiplier.
- Suppose the central bank conducts an unusually large open market purchase of bonds held by banks of $ 800 billion due to a sharp contraction in the economy. Assuming the ratios you calculated in part (a) remain the same, predict the effect on the money supply.
Expert Solution
given: C = $400 billion
D = $700 billion
ER = $50 billion
rr = 10% or 0.10
a) Money Supply = C + D = 400 +700 = $1100 billion
Cash-Deposit ratio (c) = C/D = 400/700 = 0.57
Excess reserves ratio (e) = ER/D = 50/700 = 0.07
Money Multiplier = m 1 = (1+c)/(rr+c+e) = 1.57/0.74 = 2.12
b) Monetary base = C + R where R = total reserves
When Central Bank will purchase bonds, reserves will rise and therefore monetary base will increase by $800 billion.
Change in money supply = m1 *change in monetary base = 2.12*800 = $1696 billion
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