HW11_Solutions - Homework 11 Solutions ECON 010 Fall 2011...

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Homework 11 Solutions ECON 010, Fall 2011 Assumptions: 1) Money Supply is M1. 2) Demand deposit and checking account are the same. Question 1: Money and Money Multiplier A commercial bank gets $1,000 in currency from a customer as a demand deposit. a. How much in deposits can the banking system as a whole maximally generate, if the required reserve ratio is 20%? Answer: There are $1000 x 1/RR=1000/0.2 = $5000 deposits generated from this transaction. b. How much in additional money supply is generated? Answer: Since the currency which was originally deposited was already part of the money supply, the additional money supply is $5000 - $1000 = $4000. c. What happens to the money supply if the required reserve ratio is 0%, what if it is a 100%? Answer: If the required reserve ratio was 0%, an initial deposit of $1000 would generate infinite addi- tional deposit and thus, infinite additional money supply. Conversely, if the required reserve ratio was 100%, an initial deposit of $1000 would generate only $1000 in total deposit and thus, will not change the money supply. d. How would your answer to part b) change if instead of a commercial bank getting $1000 in deposits, it instead sold $1000 worth of securities to the Federal Reserve. Answer: If instead the bank sold $1000 worth of securities to the Federal Reserve, both the deposits generated and the additional money supply generated would be $5000. 1
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Question 2: Money and Money Multiplier Use the information in the table below to answer the following questions. Last Bank of Cedar Bend Assets Liabilities Reserves: $45,000 Deposits: $150,000 Loans: $105,000 a. If the reserve requirement is 25%, calculate the amount of excess reserves that this bank holds. Answer: If the reserve requirements is 15%, then the bank is required to hold only $150,000 x 0.25 = $37,500. Therefore, this bank is holding $45,000-$37,500=$7,500 in excess reserves. b. If this bank decides to decrease its reserves to the required amount, calculate the increase in the money supply which will result from this change? Answer: An additional loan of $7,500 can generate $7,500 x 1/0.25 = $30,000 in additional money supply. Question 3: Money The economy of Elmendyn contains 2,000 $1 bills. a. If people hold all money as currency, what is the money supply in Elmendyn? Answer: If people hold all money as currency, the money supply is 2000 x $1 = $2,000. b. If people hold all money as demand deposits and banks maintain 100% reserves, what is the money supply in Elmendyn? Answer If people hold all money as demand deposits at banks with 100% reserves, the money supply is $2,000.
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