Question

An economy has a monetary base of 1,000 $1 bills. Calculate the money supply in scenarios a - d. Then answer part e. a. All money is held as currency Money supply = $ b. All money is held as demand deposits. Banks are required to hold 100% of deposits as reserves. Money supply = $ c. All money is held as demand deposits. Banks hold 20% of deposits as reserves. Money supply = $ d. People hold equal amounts of currency and demand deposits. Banks hold 20% of deposits as reserves. Round to the nearest dollar. Money supply = $ e. The central bank decides it should increase the money supply by 10%. By how much should it increase the monetary base to accomplish this goal in each scenario? Monetary base increase = $

Answer 1

Answer:

a. If all money is held as currency then the banks create no additional money and money supply is = $1,000

b. If all money is in banks but the banks are not loaning it out as they are keeping it in reserves, no loans will be created. Supply is still $1,000.

c. The total money is the amount of deposits multiplied by the money multiplier.

Money Multiplier = 1/required reserve

= 1/0.2

= 5

Supply = 1,000 * 5

= $5,000

d. With equal amounts held as currency and demand deposits, the money multiplier will be;

= $\frac{1 + Currency deposit ratio}{ Reserve requirement + Currency deposit ratio}$

Currency deposit ratio is 1 as the ratio to demand deposits is equal which = 1.

= $\frac{1 + 1}{1 + 0.2}$

= 1.67

Money supply = 1,000 * 1.67

= $1,670

e. If the Central bank increases the money supply by 10% then the monetary base would increase by;

= 10% * 1,000

= $100