Question 1 (30 marks)

The banking system plays a crucial role in carrying out monetary policy. Through the credit process within commercial banks, quantities of money are created for the economy.

a) In order to boost economic growth, the central bank of Country Y has injected $500 billion of new money into the banking system. If the required reserve ratio (RR) for bank deposits in Country Y is 20%, compute the maximum increase in money supply that the additional funds can create in the following scenarios:

i. Commercial banks in Country Y lend all their available funds to their loan customers under the current reserves requirement. At the same time, the public does not keep any cash on hand and deposit all their money to banks. (6 marks)

ii. Suppose the public keeps one third of their funds in form of cash and deposit the rest with their banks. In addition, commercial banks hold 5% excess reserves (ER) on top of the required reserve for the deposits they receive. (9 marks)

b )With reference to your answers in (a), explain in detail why a central bank in reality cannot control the exact amount of money in circulation with the practice of monetary policy. (15 marks)