1. Consider an economy with $950 billion in chequable deposits, $90 billion in desired reserves and $39 billion in excess reserves. Currency in circulation is $318 billion. (i) What is the money supply in this economy? (ii) Calculate the currency deposit ratio and the excess reserve ratio (iii) What is the money multiplier in this economy? Suppose the central bank conducts an open market purchase. Specifically, the central bank purchases $121 billion of government bonds held by banks. (iv) If the ratios calculated previously remain unchanged, what do you predict will be the effect on this economy’s money supply? (v) Consider the same open market purchase as in part (iv), except that banks choose to hold all of these proceeds as excess reserves instead of making loans. Assuming that currency and deposits remain the same, what happens to the money multiplier? Now consider a similar scenario as in part (v). That is, the central bank undertakes an open market purchase and banks choose to hold all of the proceeds as excess reserves. The only different now is that will consider an exceptionally large open market purchase (i.e., much larger than $121 billion). (vi) Would it be possible for such a large open market purchase to bring the money multiplier below 1 in this economy? If so, how big would the open purchase have to be?

Essentials of Economics (MindTap Course List)

8th Edition

ISBN:9781337091992

Author:N. Gregory Mankiw

Publisher:N. Gregory Mankiw

Chapter21: The Monetary System

Section: Chapter Questions

Problem 10PA

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1. Consider an economy with $950 billion in chequable deposits, $90 billion in desired
reserves and $39 billion in excess reserves. Currency in circulation is $318 billion.
(i) What is the money supply in this economy?
(ii) Calculate the currency deposit ratio and the excess reserve ratio
(iii) What is the money multiplier in this economy?
Suppose the central bank conducts an open market purchase. Specifically, the central
bank purchases $121 billion of government bonds held by banks.
(iv) If the ratios calculated previously remain unchanged, what do you predict will
be the effect on this economy’s money supply?
(v) Consider the same open market purchase as in part (iv), except that banks
choose to hold all of these proceeds as excess reserves instead of making loans.
Assuming that currency and deposits remain the same, what happens to the
money multiplier?
Now consider a similar scenario as in part (v). That is, the central bank undertakes
an open market purchase and banks choose to hold all of the proceeds as excess
reserves. The only different now is that will consider an exceptionally large open
market purchase (i.e., much larger than $121 billion).
(vi) Would it be possible for such a large open market purchase to bring the money
multiplier below 1 in this economy? If so, how big would the open purchase
have to be?
2. Suppose that in December the public wants to hold more currency to buy gifts and
make donations to local charities and so withdraws cash from their bank accounts.
(i) Draw a diagram illustrating how the shift from deposits into currency affects
the equilibrium in the market for reserves.
(ii) What happens to the overnight interest rate? Your answer should include a
brief explanation (i.e., a few sentences).

Definition Definition Capital reserves held by banks or financial institutions over and above the reserves that are required to be maintained by the regulator toward its liabilities and for internal controls. For commercial banks, excess reserve is the amount over the standard reserve as decided by the central bank. These excess reserve funds are available in the form of cash and cash equivalents.

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