8. The reserve requirement, open market operations, and the moneysupplyAssume 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 $300. Determine the money multiplier and the money supply for each reserve requirement listed in the following table.Reserve RequirementSimple Money MultiplierMoney Supply(Percent)(Dollars)5        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.The Fed cannot control the amount of money that households choose to hold as currency. The Fed cannot prevent banks from lending out required reserves. The Fed cannot control whether and to what extent banks hold excess reserves.

Question
Asked Dec 9, 2019
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8. The reserve requirement, open market operations, and the moneysupply

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 $300. 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)
5          
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.
The Fed cannot control the amount of money that households choose to hold as currency.
 
The Fed cannot prevent banks from lending out required reserves.
 
The Fed cannot control whether and to what extent banks hold excess reserves.
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Expert Answer

Step 1

Money multiplier is the amount of money that banks generate with each dollar of reserve.

Simple money multiplier  = 1/ Required reserve ratio

Simple money multiplier when RR is 5%

Simple money multiplier  = 1/0.05

                                          = 20

Change in Money supply = Simple money multiplier * Change in Reserves

                                         = 20 * 300

                                         = 6000

Simple money multiplier when RR is 10%

Simple money multiplier  = 1/0.1

                                          = 10

Change in Money supply = Simple money multiplier * Change in Reserves

                                         = 10 * 300

                                         = 3000

Thus, a higher reserve requirement is associated with a lower money supply.

Step 2

To increase the money supply by 200 dollars at a reserve requirement of 10% the change in reserves required is of:

 Change in Money supply  = Simple money multiplier * Change in Reserves

                                    200  = 10*R

Thus, Fed will use open market operations to buy 20 dollars worth of government bonds.

Now, when required reserve ratio is 25% the money multiplier is:

Simple money multiplier  = 1/0.25

                    ...

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