Suppose that Albert finds $2,000 in change in his couch that he deposits into his checking account at Bank A. Also suppose that the required reserve ratio is 5 percent and that banks hold no excess reserves (all excess reserves are used to make loans) and the public holds no currency.
a. Immediately after Albert makes the deposit, by how much is the money supply changed?
b. How much can the Bank A lend safely? Why?
c. What is the value of simple money multiplier? What does it tell us?
d. What will be the maximum change in the money supply by the entire banking system?
e. What will be the money supply in the economy? In which monetary aggregate it will be located, in which component?
f. If Albert makes deposit in Bank A, and Bank A decides not to lend any of excess reserves, how much deposit creation will take place for the entire banking system?
g. Refer to the original data. If the Fed increases the required reserve ratio to 10%, what will be level of excess reserves in the Bank A?
h. What happens to the money multiplier?
i. What happens to the money supply in the economy?
j. Use the concept of supply and demand for money (the money market) and illustrate the effect of the Fed action on:
The money supply
The short-term interest rates