Question

Suppose the Federal Reserve sets the reserve requirement at 12 percent, banks hold no excess reserves, and no additional currency is held. Instructions: In part a, round your answer to 2 decimal place. In parts b and c, enter your answers as whole numbers. Include any negative signs if necessary.
(a) What is the money multiplier?
(b) By how much will the total money supply change if the Federal Reserve changes the amount of reserves by -$80 million?
(c) Suppose the Federal Reserve wants to increase the total money supply by $500 million. By how much should the Federal Reserve change reserves to achieve this goal?

Answer 1

Answer:

See below.

Explanation:

For a)

The money multiplier or the credit multiplier can be calculated as follows,

Money multiplier = 1 / reserve ratio

Multiplier = 1 / 0.12 = 8.33 times

For b)

For a negative $80 million change by the Fed there will be a total change in the economy of 80 * 8.33 = $666.4 million.

A -80 million change will contract money supply by $666.4 million in the economy.

For c)

This can be calculated by dividing the target by the money multiplier.

So to achieve a change of $500m the Fed will expand the money supply by

= 500 / 8.33 = $60.02m.

Hope that helps.