U7 Template

Unit 7 Assignment
1 This section deals with increase money supply given two scenarios (see “a” and “b” below).

In Westlandia, the public holds 50% of money one (M1) in the form of currency, and the required reserve ratio is 20%. a Estimate how much the money supply will increase in response to a new cash deposit of $500 by completing the accompanying table.

(Hint: The first row shows that the bank must hold $100 in minimum reserves — 20% of the $500 deposit — against this deposit, leaving $400 in excess reserves that can be loaned out. However, since the public wants to hold 50% of the loan in currency, only $400 × 0.5 = $200 of the loan will be deposited in round 2 from the loan granted in Round 1.)
Round
Deposits
Required reserves
Excess reserves
Loans
Loan proceeds held as currency
Loan proceeds deposited
1
$500.00
$100.00
$400.00
$400.00
$200.00
$200.00
2
$200.00

3

4

5

6

7

8

9

10

Totals

b) How does your answer compare to an economy in which the total amount of the loan is deposited in the banking system and the public does not hold any of the loans in currency? (Hint: Complete the table below when none of the loan proceeds held in currency following the example for row 1.)
Round
Deposits
Required reserves
Excess reserves
Loans
Loan proceeds held as currency
Loan proceeds deposited
1
$500.00
$100.00
$400.00
$400.00
0.00
$400.00
2
$400.00

3

4

5

6

7

8

9

10

Totals

c) What does this imply about the relationship between the public’s desire for holding currency and the money multiplier? Which scenario will contribute more to increase in money supply?

2 Explain how each of the following changes quantity of money (money supply) in the economy.

a. the Fed buys bonds
b.
the Fed auctions credit
c.
the Fed raises the discount rate
d.
the Fed raises the reserve requirement

3 Assume that in a country the total holdings of banks were as follows:

Amount in million dollars
Required Reserve
$45
Excess Reserve
$15
Deposits
$750
Loans
$600
Treasury Bonds
$90

Show that the balance sheet balances if these are the only assets and liabilities.
Assuming that people hold no currency, what happens to each of these values if the central bank changes the reserve requirement ratio to 2%, banks still want to hold the same percentage of excess reserves, and banks do not change their holdings of Treasury bonds? How much does the money supply change by?