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ECON 103 Chapter Notes - Chapter 16-3: Excess Reserves, Money Multiplier, Reserve Requirement

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goldshark321
8 Oct 2016
School
University of Illinois
Department
Economics
Course
ECON 103
Professor
Mc Dermott Eric

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Document Summary

Amount of money you hold = currency (bills and coins in wallet) + demand deposits (balance in checking account) Demand deposits held in bands, so behavior of banks can influence quantity of demand deposits in economy and, therefore, the money supply. Reserves = deposits that banks have received but not loaned out. A bank"s assets = reserves held in vaults + loans: these loans are liabilities of the borrowers, but are assets of the bank because the borrowers will later repay the loans. A bank"s liabilities = amount the depositors deposit. If banks hold all deposits in reserve, banks do not influence the supply of money. If bank is holding and has not loaned any money out, it has in assets (reserves) and in deposits (liabilities) Fractional-reserve banking= banking system in which banks hold only a fraction of deposits as reserves. Money supply when all deposits are in reserve = .

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Related Questions

Explain the following statement whether true or false.

1- Assume that when $80,000 cash enters the banking system, the money supply ultimately increases by $320,000. Assume also that all banks do not hold excess reserves and that the entire money supply consists of demand deposits. Then the total legal reserves for all banks will amount to $40,000, and total loans and investments for all banks will be equal to $ 280,000.

2- Banks cannot affect or contribute to changes in the money supply if they were required to hold all reserve deposits.

3-Nowadays, a credit card is similar to a check, in money definition, according to macroeconomics.

Assume that banks do not hold excess reserves and that households do not hold currency, so the only form of money is demand deposits. To simplify the analysis, suppose the banking system has total reserves of $400. Determine the money multiplier and the money supply for each reserve requirement listed in the following table.

Reserve Requirement Simple Money Multiplier Money Supply
(Percent) (Dollars)
20    
10    

A higher reserve requirement is associated with a money supply.

Suppose the Federal Reserve wants to increase the money supply by $200. Again, you can assume that banks do not hold excess reserves and that households do not hold currency. If the reserve requirement is 10%, the Fed will use open-market operations to worth of U.S. government bonds.

Now, suppose that, rather than immediately lending out all excess reserves, banks begin holding some excess reserves due to uncertain economic conditions. Specifically, banks increase the percentage of deposits held as reserves from 10% to 25%. This increase in the reserve ratio causes the money multiplier to to . Under these conditions, the Fed would need to worth of U.S. government bonds in order to increase the money supply by $200.

Which of the following statements help to explain why, in the real world, the Fed cannot precisely control the money supply? Check all that apply.

  1. The Fed cannot control the amount of money that households choose to hold as currency.
  2. The Fed cannot prevent banks from lending out required reserves.
  3. The Fed cannot control whether and to what extent banks hold excess reserves.

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.