Fed and Money Supply

Assume that the reserve requirement is 20%, that banks hold no excess reserves, and that Currency = 0.And that the Fed wishes to decrease the money supply by $400 million in the traditional manner by selling bonds to primary dealers who withdraw the funds at a commercial bank with a reserve account at the Fed.

(i)If the Fed is using open-market operations, will it buy or sell bonds?(-

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(ii)What quantity of bonds does the Fed need to buy or sell to accomplish its goal?Show your work.(-

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3.Question #3

Assume a banking system with deposits, currency, and required reserves, but no excess reserves.Suppose you find $200 under your mattress and deposit it in a checking account at your local bank, which has no excess reserves.

(3 points; 0.75 points per section)

(a)By how much do excess reserves increase after you make the deposit if the reserve requirement equals 10%?(-

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(b)In this first step, has the money supply, M1, changed?(Hint:have deposits increased?Has currency in the hands of the public decreased?Remember that M1 = currencyin hands of public + deposits.(-

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(c)Now assume that the money multiplier equals 5 (it's not just 1/0.1, since we allow currency in the model, which changes how we compute the money multiplier; and, no, we did not review the specifics!), what is the maximum amount of new checkable deposits that can be created?(Hint:simply the amount of excess reserves computed in (a) and multiply this number by the money multiplier.)(-

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(d)By how much does the total money supply (M1 = currency + checkable deposits) in the banking system increase?(-

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