1. AP Macroeconomics
2004
Question 3

2. 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

3. 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

4. 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
$ Required
Reserves
$4,500 Excess
Reserves
First Generation Bank

5. 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
$ Required
Reserves
$4,500 Excess
Reserves
First Generation Bank

6. 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
$ Required
$4,500 Excess

7. (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
$ Required
$4,500 Excess

8. 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
$ Required
$4,500 Excess