Answer:
the money multiplier = 1 / reserve ratio
in this case, the reserve ratio is 10% (required) + 10% (voluntary) = 20%, so the money multiplier = 1/20% = 5
What is the immediate impact of this transaction on the money supply?
- None, since the money supply doesn't change. When a customer deposits money in a bank, the money does not increase, only its composition changes.
The maximum amount by which this bank will increase its loans from the transaction in part (a)
- the bank will be able to loan ⇒ total deposit x (1 - reserve ratio) = $9,000 x (1 - 20%) = $7,200
The maximum increase in the money supply that will be generated from the transaction in part
- since the banks started to "create" money by lending the money, the money supply will increase by ⇒ total deposit x (money multiplier - 1) = $9,000 x 4 = $36,000
Assume that the government increases spending by $9,000, which is financed by a sale of bonds to the central bank. Indicate what will happen to the money supply.
- The money supply will increase.
Explain what will happen to the money demand.
- The money demand will also increase because aggregate demand and income will increase. Aggregate demand will increase by ⇒ $9,000 x government multiplier. The government multiplier = 1 / MPS.
