Suppose the Federal Reserve needs to raise the interest rate by 1 point. Use the graph below to decide on the appropriate course of action if the reserve requirement is 0%, but banks like to hold 10% of deposits as reserves and the public likes to hold 3% of their money as cash.

Suppose the Federal Reserve needs to raise the interest rate by 1 point. Use the graph below to decide on the appropriate course of action if the reserve requirement is 0%, but banks like to hold 10% of deposits as reserves and the public likes to hold 3% of their money as cash.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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Concept explainers

Required Reserve and Excess Reserve Analysis

A required reserve is an amount of cash that banks must keep with themselves, which is certain percentage of the deposits made by their customers. Required reserve is a percentage of the bank's deposits that the respective bank must have on each overnight. The percentage rate is set and determined by the nation’s central bank. It is important to have such funds accumulated to meet its uncertain obligations, sudden liabilities and withdrawals. Required reserve is also known as reserve ratio. Reserve ratio is an important tool to control the money supply.

Question

Suppose the Federal Reserve needs to bring inflation under control and decides to
raise the interest rate by 1 point. Use the graph below to decide on the appropriate
course of action if the reserve requirement is 0%, but banks like to hold 10% of
deposits as reserves and the public likes to hold 3% of their money as cash.
i
5%
4%
MA
$1250 $1600
O Buy $45.5 billion in bonds
O Sell $350 billion in bonds
Buy $2692.30 billion in bonds
Buy $26.92 billion in bonds
O Sell $45.5 billion in bonds
O Sell $26.92 billion in bonds
MB
O Buy $350 billion in bonds
D Money
QMoney (billions)

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None
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