Question

Assume that banks do not hold excess reserves and that households do not hold currency - the only form of money is demand deposits. Suppose the banking system has total reserves of $500 billion. Find the money multiplier and the money supply for each reserve requirement listed in the following table:A - RR = 5%B - RR = 10%For a given level of reserves, a lower reserve requirement is associated with a _____ money supplySuppose the Federal Reserve (the Fed) wants to increase the money supply by $500 billion. Again, you can assume that banks do not hold excess reserves and that households do not hold currency. If the reserve requirement is 10%, the Fed will use open-market operations to _____ _____ worth of U.S. government bondsNow, suppose that rather than immediately lending out all excess reserves, banks begin holding some excess reserves due to uncertain economic conditions. Specifically, in addition to the required reserves of 10%, banks hold an additional 40% of their deposits as reserves. This increase in the reserve ratio causes the money multiplier to _____ to _____. Under these conditions, the Fed would need to _____ _____ worth of U.S. government bonds in order to increase the money supply by $500 billion.Which of the following statements help to explain why, in the real world, the Fed cannot precisely control the money supply? Check all that apply.A- The Fed cannot prevent banks from lending out required reserves.B- The Fed cannot control the amount of money that households choose to hold as currency.C- The Fed cannot control whether and to what extent banks hold excess reserves.

Answer 1

Answer:

A. If the reserve requirement is 5% then money multiplier is 20 and the the money supply for each reserve requirement is $10,000 billion

B. If the reserve requirement is 10% then money multiplier is 10 and the the money supply for each reserve requirement is $5,000 billion

For a given level of reserves, a lower reserve requirement is associated with a larger money supply. Suppose the Federal Reserve (the Fed) wants to increase the money supply by $500 billion. Again, you can assume that banks do not hold excess reserves and that households do not hold currency. If the reserve requirement is 10%, the Fed will use open-market operations to buy $50 billion worth of U.S. government bonds. Now, suppose that rather than immediately lending out all excess reserves, banks begin holding some excess reserves due to uncertain economic conditions. Specifically, in addition to the required reserves of 10%, banks hold an additional 40% of their deposits as reserves. This increase in the reserve ratio causes the money multiplier to fall to 2. Under these conditions, the Fed would need to buy $250 billion worth of U.S. government bonds in order to increase the money supply by $500 billion.

The following statements help to explain why the Fed cannot precisely control the money supply are:

B- The Fed cannot control the amount of money that households choose to hold as currency.

C- The Fed cannot control whether and to what extent banks hold excess reserves.

Explanation:

A. If the reserve requirement is 5% then money multiplier is 20 (= 100%:5%) and the the money supply for each reserve requirement is $10,000 billion (=$500 billion x 20)

B. If the reserve requirement is 10% then money multiplier is 10 (= 100%:10%) and the the money supply for each reserve requirement is $5,000 billion (=$500 billion x 10)