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ECON 201 Lecture Notes - Lecture 16: Fractional-Reserve Banking, Money Multiplier, Reserve Requirement

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maroonhyena988
22 Mar 2016
School
University of Maryland
Department
Economics
Course
ECON 201
Professor
Naveen Sarna

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ECON 201 Full Course Notes
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Document Summary

Bank has created o this money will eventually find its way into a second bank o deposited into second bank, can be lent out o overall money supply has increased: m = 171 + 100 = 271 o third bank can lend out 72. 90, reserves 8. 10. Federal funds rate interest rate on loans when a bank loans another bank (what one bank charges another: banks control this rate, this is the rate the federal reserve will target o many interest rates highly correlated, so changes in the fed funds rate can cause changes in other rates and have a big impact in the economy, federal open market committee (fomc) uses omos to target fed funds rate o federal open market committee gets info from 12 fed reserve banks, meet about 9x a year o based on that info, they come up with one number a target federal funds rate o.

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Related Questions

Consider the following information about the banking system:

Reserves (R) = $500 billion

Currency (C) = $400 billion

Required Reserves (RR) = $80 billion

Required Reserve Ratio (r) = 0.1

a. What is the value of excess reserves in the banking system?

b. What is the value of deposits in the banking system?

c. What is the value of the money supply (M1)?

d. What is the size of the monetary base?

e. What is the value of the money multiplier? What does it tell us?

f. If the excess reserve ratio increases by 0.06, while the value of the required reserve ratio and currency to deposits ratio stay the same, what will be the value of the money multiplier? The value of the money supply?

g. If the Fed wishes to have the value of the money supply in the economy at the initial level (part c), how should it respond?

h. How much in government bonds should the Fed sell or buy?

i. If the Fed buys from Chase 10 million in government bonds, given the money multiplier in part f, what would be the change in the money supply?

Multiple choice.
• Which of the following is NOT a monetary policy instrument?
(a) Reserve requirement ratio.
(b) Interest on reserves.
(c) Capital gains tax rate.
(d) Open market operations.
• Given the same monetary base, the money supply is greatest under:
(a) A system without banks.
(b) 100% reserve banking.
(c) Fractional-reserve banking.
•Which of the following is NOT a function of money?
(a) Store of value.
(b) Unit of account.
(c) Medium of exchange.
(d) None of the above.
• Which of the following are included in the M1 money supply measure?
(a) 1oz of gold.
(b) A $10 bill, in mint condition.
(c) The balance of a checking account at a local bank branch.
(d) A certificate of deposit (CD, time deposit) for $1000.
(e) Answers (b) and (c).

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.