CAS EC 102 Lecture Notes - Lecture 25: Excess Reserves, Reserve Requirement, Money Supply

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CAS EC 102 Full Course Notes

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Reserves: vault cash, deposits with the fed. Deposits: savings deposits, checking deposits, bank capital, = a - l. Change in total deposits = initial deposits x 1/(r+e: where r = reserve requirement. Change in money supply = change in total deposits + change in cash held by the public. The money multiplier: change in total deposits = initial deposits x (1/r+e) E = excess reserves: change in money supply = change in total deposits + change in cash held by the public, example 1: Change in total deposits = initial deposits x (1/r+e: = ,000 x (1/. 1, = ,000 x 10, = ,000. Change in money supply = change in total deposits + change in cash held by the public: = ,000 + ( -,000, = ,000, example 2: Change in total deposits: = ,000 x (1/. 1+. 1, = ,000 x 5, = ,000.

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Assume that the banking system has total reserves of $100 million. Assume also that the reserve requirement for checking deposits is 10 percent and that banks do not hold any excess reserves. There is also no currency held by households.

a) What is the money multiplier? What is the money supply?

b) If the FED raises required reserves to 20 percent of deposits, what are the change in reserves and the change in money supply?

c) Now suppose the FED lowers the requirement from 10 percent to 5 percent, but banks choose to hold another 5 percent of deposits as excess reserves. Why might banks do so? What is the overall change in the money multiplier and the money supply as a result of these actions?

d) If the FED sells $1 million of government bonds, what is the effect on the economy's reserves and money supply? Use 10 percent required reserve ratio.

e) If the FED buys $5 million of government bonds, what is the effect on the economy's reserves and money supply? Use 10 percent required reserve ratio.

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The money supply consists of Currency + Checkable Deposits (NOT including currency in bank's vaults and NOT including banks' deposits at the Fed). Before the First National Bank made the $90 loan, no one outside the bank held any currency, and Checkable Deposits were equal to 100, so the money supply was equal to 0 + 100 = 100.

When the First National Bank made the loan, the borrower received $90 in cash, but checkable deposits did not fall. Thus, the money supply was equal to $ (..........)of currency in the hands of the non-bank public plus $(........) of Deposits, for a total of $(............).

While cleaning your apartment, you find a $50 bill under the sofa cushion. You deposit the $50 into your checking account. If the reserve requirement is 20%, what is the maximum amount that the money supply could ultimately increase? (Remember that the money supply is Currency + Deposits - and that the amount of Currency fell by $50 when you put the cash in the bank).

The change in currency would be (...............) and the maximum ultimate change in deposits would be at most(..............) , so the money supply would rise by at most(..........) .

Suppose you deposit the $50, but the bank chooses not to lend any of its excess reserves. By how much would the money supply ultimately increase in this case?

The change in currency would be (................) and the ultimate change in deposits would be(............) , so the money supply would rise by(...........) .

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CAS EC 102 Lecture Notes - Lecture 25: Excess Reserves, Reserve Requirement, Money Supply

CAS EC 102 Full Course Notes

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