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Chapter 29: Problem 10

Although the U.S. Federal Reserve doesn't use changes in reserve requirements to manage the money supply, the central bank of Albernia does. The commercial banks of Albernia have \(\$ 100\) million in reserves and \(\$ 1,000\) million in checkable deposits; the initial required reserve ratio is \(10 \%\). The commercial banks follow a policy of holding no excess reserves. The public holds no currency, only checkable deposits in the banking system. a. How will the money supply change if the required reserve ratio falls to $5 \%$ ? b. How will the money supply change if the required reserve ratio rises to $25 \%$ ?

Short Answer

Expert verified
Answer: When the required reserve ratio falls to 5%, the money supply will increase by $1,000 million. When it rises to 25%, the money supply will decrease by $600 million.

Step by step solution

01

Calculate initial money supply

First, let's calculate the initial money supply given the required reserve ratio of \(10\%\). The money multiplier formula is: `Money Multiplier = 1 / Required Reserve Ratio` So, the initial money multiplier is: `Initial Money Multiplier = 1 / 0.10 = 10` Now, we can calculate the initial money supply by multiplying the initial money multiplier by the total reserves: `Initial Money Supply = Initial Money Multiplier × Total Reserves = 10 × \$100\( million = \)\$1,000$ million.
02

Case a: Required reserve ratio falls to 5%

To calculate the new money supply when the required reserve ratio falls to \(5\%\), we need to first calculate the new money multiplier. `New Money Multiplier = 1 / 0.05 = 20` Now, we can calculate the new money supply: `New Money Supply = New Money Multiplier × Total Reserves = 20 × \$100\( million = \)\$2,000$ million. The change in the money supply is: `Change in Money Supply = New Money Supply - Initial Money Supply = \$2,000\( million - \$1,000\) million = \(\$1,000\) million. So, if the required reserve ratio falls to \(5\%\), the money supply will increase by \(\$1,000\) million.
03

Case b: Required reserve ratio rises to 25%

Now, let's calculate the new money supply when the required reserve ratio rises to \(25\%\). The new money multiplier is: `New Money Multiplier = 1 / 0.25 = 4` Then, the new money supply is: `New Money Supply = New Money Multiplier × Total Reserves = 4 × \$100\( million = \)\$400$ million. Finally, the change in the money supply is: `Change in Money Supply = New Money Supply - Initial Money Supply = \$400\( million - \$1,000\) million = \(-\$600\) million. In this case, if the required reserve ratio rises to \(25\%\), the money supply will decrease by \(\$600\) million.

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Most popular questions from this chapter

There are three types of money: commodity money, commodity-backed money, and fiat money. Which type of money is used in each of the following situations? a. Bottles of rum were used to pay for goods in colonial Australia. b. Salt was used in many European countries as a medium of exchange. c. For a brief time, Germany used paper money (the "Rye Mark") that could be redeemed for a certain amount of rye, a type of grain. d. The town of Ithaca, New York, prints its own currency, the Ithaca HOURS, which can be used to purchase local goods and services.

The Congressional Research Service estimates that at least \(\$ 45\) million of counterfeit U.S. \(\$ 100\) notes produced by the North Korean government are in circulation. a. Why do U.S. taxpayers lose because of North Korea's counterfeiting? b. As of December 2014 , the interest rate earned on one-year U.S. Treasury bills was \(0.13 \%\). At a \(0.13 \%\) rate of interest, what is the amount of money U.S. taxpayers are losing per year because of these \(\$ 45\) million in counterfeit notes?

Show the changes to the T-accounts for the Federal Reserve and for commercial banks when the Federal Reserve buys \(\$ 50\) million in U.S. Treasury bills. If the public holds a fixed amount of currency (so that all loans create an equal amount of deposits in the banking system), the minimum reserve ratio is $10 \%$, and banks hold no excess reserves, by how much will deposits in the commercial banks change? By how much will the money supply change? Show the final changes to the T-account for commercial banks when the money supply changes by this amount.

Tracy Williams deposits \(\$ 500\) that was in her sock drawer into a checking account at the local bank. a. How does the deposit initially change the T-account of the local bank? How does it change the money supply? b. If the bank maintains a reserve ratio of \(10 \%\), how will it respond to the new deposit? c. If every time the bank makes a loan, the loan results in a new checkable bank deposit in a different bank equal to the amount of the loan, by how much could the total money supply in the economy expand in response to Tracy's initial cash deposit of \(\$ 500 ?\) d. If every time the bank makes a loan, the loan results in a new checkable bank deposit in a different bank equal to the amount of the loan and the bank maintains a reserve ratio of \(5 \%,\) by how much could the money supply expand in response to Tracy's initial cash deposit of \(\$ 500 ?\)

Show the changes to the T-accounts for the Federal Reserve and for commercial banks when the Federal Reserve sells \(\$ 30\) million in U.S. Treasury bills. If the public holds a fixed amount of currency (so that all new loans create an equal amount of checkable bank deposits in the banking system) and the minimum reserve ratio is \(5 \%\), by how much will checkable bank deposits in the commercial banks change? By how much will the money supply change? Show the final changes to the T-account for the commercial banks when the money supply changes by this amount.
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