AP Macroeconomics 2004 Question 3

The FED gives CCS $5,000 in return for a bond. The Federal Reserve buys $5,000 in bonds from Clark Consulting Services, which then deposits the money in a checking account at First Generation Bank. As a result of the Federal Reserve’s actions, what is the change in the money supply if the required reserve ratio is 100 %? The FED gives CCS $5,000 in return for a bond. Increase in the money supply of $5,000. The reserve requirement is 100%, the $5,000 of cash reserves are now required reserves. CCS then deposits the $5,000 into the bank, which is required to hold 100%. Assets Liabilities $5,000 Cash Reserves Required Reserves $5,000 DD First Generation Bank

If the required reserve ratio is reduced to 10 percent, calculate the following. The maximum amount this bank could lend from this deposit. Now the bank does NOT have to hold 100% of cash reserves It only has to hold 10%. Assets Liabilities $5,000 Cash Reserves $5,000 DD First Generation Bank

If the required reserve ratio is reduced to 10 percent, calculate the following. The maximum amount this bank could lend from this deposit. The cash reserves now are broken up into required reserves and excess reserves: Assets Liabilities $5,000 Cash Reserves $5,000 DD $ 500 Required Reserves $4,500 Excess Reserves First Generation Bank

The maximum amount the bank can lend is If the required reserve ratio is reduced to 10 percent, calculate the following. The maximum amount this bank could lend from this deposit. The maximum amount the bank can lend is $4,500, its excess reserves. Assets Liabilities $5,000 Cash Reserves $5,000 DD $ 500 Required Reserves $4,500 Excess Reserves First Generation Bank

If the required reserve ratio is reduced to 10 percent, calculate the following. The maximum increase in the total money supply from the Federal Reserve’s purchase of bonds To calculate the increase in money supply => take excess reserves ($4,500) times the money multiplier 10 = $45,000 + the original increase of $5,000 Total increase in the MS of $50,000. Assets Liabilities First Generation Bank $5,000 DD $5,000 Cash Reserves $ 500 Required $4,500 Excess

(c ) If banks keep some of the deposit as excess reserves, how will this influence the change in the money supply that was determined in part (b)(ii)? Explain. If the banks hold some of the excess reserves => increase in the money supply would be less than $50,000 => banks lend less money => less money creation Assets Liabilities First Generation Bank $5,000 DD $5,000 Cash Reserves $ 500 Required $4,500 Excess

The increase in the money supply would be less than $50,000. If the public decides to hold some money in the form of currency rather than in demand deposits, how will this influence the change in the money supply that was determined in part (b)(ii)? Explain. The increase in the money supply would be less than $50,000. Banks get less money => Banks lend less money => MS rises by less Assets Liabilities First Generation Bank $5,000 DD $5,000 Cash Reserves $ 500 Required $4,500 Excess