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Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985

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BuyFindarrow_forward

Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985
Textbook Problem

If the reserve ratio is ¼ and the central bank increases the quantity of reserves in the banking system by $120, the money supply increases by

a. $90.

b. $150.

c. $160.

d. $480.

To determine

The money created by the banks.

Explanation

The Federal Reserve is the central bank of the US economy and it is usually known as the Fed. The Fed has the responsibility to keep the economy controlled from the fluctuations and it also has to control the money supply of the economy through its monetary policies. The controlling of the money supply is one of the prime most responsibilities of the Fed.

The banks are financial institutions that play an important role in a financial market. They are the institutions that accept the excess savings of people as deposits and use the deposits to provide loans to the needy people. The banks provide interest to the depositors and collects higher interests from the borrowers. The money creation of the banks takes place in this manner. The money created out of every dollar of reserve by the financial institution bank is known as the multiplier. The multiplier is usually reciprocal of the reserve ratio and here the reserve ratio is equal to 14 , which means that the multiplier value is the reciprocal (which is 4). Thus, the money created can be calculated by multiplying the increased reserves with the multiplier as follows:

Money created by banks=Increased reserves

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