Suppose that currency in circulation is $500 billion, the amount of checkable deposits is $1,000 billion, excess reserves are $150 billion, and the required reserve ratio on checkable deposits is 10%.
a. Calculate the money supply, the monetary base, the currency deposit ratio, the excess reserve ratio, and the money multiplier.
b. Suppose the central bank conducts a large open market purchase of bonds held by banks of $250 billion due to a sharp contraction in the economy. Assuming the ratios you calculated in part a are the same, what do you predict will be the effect on the money supply?
c. Suppose the central bank conducts the same open market purchase as in part b, except that banks choose to hold all of these proceeds as excess reserves rather than loan them out, due to fear of a financial crisis. Assuming that currency and deposits remain the same, what happens to the amount of excess reserves, the excess reserve ratio, the money supply, the monetary base, and the money multiplier?
d. Following the financial crisis in 2008, the Federal Reserve began injecting the banking system with massive amounts of liquidity, and at the same time, very little lending occurred. As a result, the M1 money multiplier was below 1 for most of the time from October 2008 through 2011. Is it possible for the money supply to remain the same while the money multiplier declines? Why or why not?