Question 5

Suppose that the required reserve ratio is 9%, currency in circulation is $620 billion, the amount of checkable deposits is $950 billion, and excess reserves are $15 billion.

a.Calculate the money supply, the currency deposit ratio, the excess reserve ratio, and the money multiplier. (5 marks)

b.If the Fed sells $600 million of bonds to the First National Bank, what happens to reserves, the monetary base, and the money supply, based on the money multiplier from Question (a)? Use T-accounts to explain your answer. Please show the required reserve and excess reserve, respectively. The required reserve ratio is 10%. (10 marks)

c.Based on Question (a), suppose the central bank conducts an unusually large open market purchase of bonds held by banks of $ 1,300 billion due to a sharp contraction in the economy. Assuming the ratios you calculated in part (a) remain the same, predict the effect on the money supply. (5 marks)

d.Suppose the central bank conducts the same open market purchase as in part (b), except that banks choose to hold all of these proceeds as excess reserves rather than loan them out, due to fear of a financial crisis. Assuming that currency and deposits remain the same, what happens to the amount of excess reserves, the excess reserve ratio, the money supply, and the money multiplier? (5 marks)