Question
a) If the reserve requirement is 10 percent and banks hold no excess reserves, what is the deposit expansion multiplier?Briefly describe why it is possible
a) If the reserve requirement is 10 percent and banks hold no excess reserves, what is the deposit expansion multiplier?Briefly describe why it is possible for the money supply to increase by more than the amount of a new deposit.
b.) Suppose that by the end of this year, we are in a boom phase and the Federal Reserve wishes to decrease the money supply by $400 billion in order to limit price inflation (assume that there is the same reserve requirement and no excess reserves as part a).If the Fed wanted to use open market operations, would the Fed buy or sell bonds and how many bonds should the Fed buy or sell?
c.) Now assume that banks are more cautious about lending and instead of having no excess reserves, all banks decide to keep 20 percent of all deposits in reserves (the 10 percent that is required PLUS an additional 10 percent, which would be called excess reserves).If this is the case, would your answer to part b) change (and if so, by how much) if the Federal Reserve had the same goal (decrease the money supply by $400 billion) with banks now holding an amount of excess reserves described above?
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