Principles of Economics (12th Edition)
12th Edition
ISBN: 9780134078779
Author: Karl E. Case, Ray C. Fair, Sharon E. Oster
Publisher: PEARSON
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Chapter 25, Problem 2.2P
To determine
The change in the money supply of an economy with the increase in the reserve ratio.
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Suppose again that checkable deposits started off at $400,000 in First Main Street Bank, the required reserve ratio is 15%, and no excess reserves and no cash leakage exist.
You know from the previous step that, due to the sale of securities by the Fed, the money supply in the economy contracted from $400,000 to $392,000. But the contraction of the money supply does not stop with First Main Street Bank. It moves to other banks. The loan repayment that Charles made to First Main Street Bank was written on a check Second Republic Bank issued. Then, when the check cleared, the reserves of Second Republic Bank declined, and Second Republic Bank found itself reserve deficient as well. It applied loan repayments to its reserve deficiency position.
The effect continued with other banks and so on.
The initial removal of funds in the amount of $8,000 will cause the money supply to contract by $______. Therefore, the money supply is $______. (Hint: round the results of your calculations to the…
If the Fed wishes to increase the money supply, it can:
Question 11 options:
buy bonds from a bank, giving the bank cash in return, which it can then lend out.
sell a bond to bank, and take the money it receives in exchange out of circulation in the economy.
buy a bond from a bank, requiring the bank to hold the money it receives as excess reserves.
sell a bond to a bank, and take the money it receives and lend it out to someone else.
Suppose you examine the central bank’s balance sheet and observe that since the previous day, reserves had risen by $400 million. In addition, on the asset side of the central bank’s balance sheet, securities had risen by $400 million. What activity did the central bank carry out earlier in the day to lead to these changes in the balance sheet? Do you think by carrying out this activity the central bank was aiming to increase, decrease, or maintain the size of the money supply?
The central bank conducted an open market (purchase /sale) of $400 million with a commercial bank. This transaction would involve $400 million of securities being ( added to / removed from) the central bank’s balance sheet. There would be (an increase / a fall ) of $400 million in reserves to reflect the related payment ( to / by ) the commercial bank ( from / into) its reserve account. By carrying out this activity, the central bank was aiming to (increase / decrease) maintain the size of the money supply.
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Principles of Economics (12th Edition)
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- Suppose you found Rs. 2000 that was stored under your grandmother's mattress and you decided to deposit this money in a Bank of India. If the desired reserve ratio were 20 percent and all excess reserves were lent out. a) Calculate the money supply created by this deposition in the economy?b) Following a new deposit of Rs. 2000, what is the reserve requirement of the commercial bank?c) Suppose all the banks in the banking system collectively have Rs.20 million in cash reserves and have a desired reserve ratio of 20 percent, the maximum amount of demand deposits the banking system can support is?arrow_forwardChina Cuts Reserve Requirements Beijing—China's central bank reduced the amount of reserves commercial banks are required to hold, freeing up money for lending in the latest easing measure to shore up the world's second-largest economy. The People's Bank of China's percentage point cut in the reserve requirement lowers the reserve-requirement ratio, or RRR, to 11.5 percent for large banks. The move frees up about US$79 billion in additional funds that banks can now lend. What was the money multiplier in China before the change in reserve requirements?arrow_forwardChallenge Problem. The chapter mentions that an open market operation by the Fed can increase or decrease the quantity of deposits in banks and therefore the money supply. The change in the money supply from a Fed open market operation is given by the following equation: Change in money supply = Change in reserves x1/ (RR+ ER) where RR = the percentage of deposits that banks are required to keep as reserves ER = the percentage of deposits that banks voluntarily hold as excess reserves 1/ (RR+ ER) = the "money multiplier" Suppose the Fed decides to sell $16 billion in Treasury bonds. Assume that the reserve requirement is 10 percent, banks hold 3 percent in excess reserves, and the public holds no cash. This action by the Fed causes the money supply to by S billion. (Round your response to two decimal places.)arrow_forward
- The interest rate on reserves is the interest rate that the Fed pays banks for holding reserves on deposit at the Fed. For many years, open market operations were the Fed’s primary tool for monetary policy. However, since October 2008, it relies more on interest on reserves. A decrease in the interest rate on reserves tends to (decrease or increase) the reserve ratio, (decreases or increases) the money multiplier, and (decrease or increase) the money supply.arrow_forwardSuppose again that checkable deposits started off as $400,000 in First Main Street Bank, the required reserve ratio (r) is 15%, with and there are no excess reserves and no cash leakage. Suppose the Fed buys $8,000 worth of government securities from First Main Street Bank. Complete the following table to reflect the Fed's purchase on the balance sheet for First Main Street Bank. Reserves Loans Assets Liabilities Checkable Deposits $400,000 Does First Main Street Bank have any excess reserves now? No; the bank has zero excess reserves. OYes; the bank has $1,200 in excess reserves. O Yes; the bank has $51,000 in excess reserves. Yes; the bank has $8,000 in excess reserves.arrow_forwardA commercial bank named First Lender initially holds the required amount of reserves at the Fed. Imagine that the Fed conducts an open-market operation and buys $30,000 of bonds from First Lender. Assume that the reserve requirement is 25%. What is the maximum possible amount that the national money supply could increase as a result of the open-market operation? $120,000 $240,000 $60,000 $22,500arrow_forward
- part 10.arrow_forwardHomework (Ch 34) a central bank called the Fed, but a major difference is that this economy is closed (and therefore does not have any interaction with other world economies). The money market is currently in equilibrium at an interest rate of 2.5% and a quantity of money equal to $0.4 trillion, designated on the graph by the grey star symbol. INTEREST RATE (Percent) 4.5 4.0 3.5 3.0 2.5 2.0 - 1.5 + 1.0 + 0.5 0 Money Demand 0.1 0.2 0.3 0.4 Money Supply 0.5 0.6 0.7 0.8 14 New MS Curve + New Equilibrium ? Q Search this coursearrow_forwardSuppose you win on a scratch-off lottery ticket and you decide to put all of your $3,500 winnings in the bank. The reserve requirement is 5%. What is the maximum possible increase in the money supply as a result of your bank deposit? maximum increase: $ Which events could cause the increase in the money supply to be less than its potential? Banks choose to loan out all excess reserves. Some loan recipients choose to hold some cash instead of depositing all of it in banks. Banks decide to keep some excess reserves on hand. All money loaned out is deposited back into the banking system.arrow_forward
- Most people in the country of Classica tend to keep $3 out of every $100 of their cash holdings in their wallets. The central bank has instructed the commercial banks to also hold 4% of all bank deposits as reserves. Calculate the extended money multiplier Suppose that in 2018 customers deposit $4,000 into their bank accounts. Based on the extended money multiplier calculated in part (i), calculate the total amount which the money supply in the banking system will eventually increase to. Show all steps involved in the calculation.arrow_forwardPaying Interest on Reserves-Problem Solving Exercise 3 (Algo) The U.S. economy is experiencing a recession. In order to smooth the economy the Federal Reserve would like to adjust the interest rate it pays on reserves. If the Fed has a goal of increasing the money supply by $25 billion, what should the change in excess reserves be if the reserve requirement is 10%? Instructions: Enter your answer as a positive number rounded to two decimal places. Excess reserves will need to (Click to select) by $ billion.arrow_forwarda) Explain whether each of the following events increases or decreases the money supply. The State Bank of Pakistan sells bonds in open-market operations. The State Bank of Pakistan increases the reserve requirement. The State Bank of Pakistan reduces the interest rate it pays on reserves. MCB Bank repays a loan it had previously taken from the State Bank of Pakistan. After a rash of pickpocketing, people decide to hold less currency. Fearful of bank runs, bankers decide to hold more excess reserves. kindly solve 4, 5, 6arrow_forward
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