Question

Assume that the banking system has total reserves of $200 billion. Assume also that required reserves are 12.5 percent of checking deposits and that banks hold no excess reserves and households hold no currency. The money multiplier is ................... The money supply is $ ........................billion. Suppose the Fed raises required reserves to 16 percent of deposits. The new money multiplier is ................... , and the money supply Increases/Decreases to $ .................billion.

Answer 1

Answer: The answer is as follows:

Explanation:

Given that,

Total reserves = $200 billion

Required reserves = 12.5 % of checking deposits

Therefore,

(a) Money multiplier = $\frac{1}{Required\ Reserve}$

                          = $\frac{100}{12.5}$

                          = 8

(b) Money supply = Money multiplier × Total reserves

                            = 8 ×  $200 billion

                            = $1,600 billion

(c) Now, if Fed increases the required reserves to 16% of deposits.

    New Money multiplier = $\frac{1}{Required\ Reserve}$

                          = $\frac{100}{16}$

                          = 6.25

    New Money supply = Money multiplier × Total reserves

                            = 6.25 ×  $200 billion

                            = $1,250 billion

    Money supply decreases to $1,250 billion.