Suppose that the public wishes to hold $0.35 in pocket money (currency and coin) and $0.25 in time and savings deposits. Suppose that banks wish to hold $0.20 for each new dollar of transaction money received. Suppose that $0.05 finds its way outside of the domestic banking system. Suppose the reserve requirement on transaction deposits is 3 percent and that on time and savings deposits is 4%.
a. What is the size of the transaction deposit multiplier?
b. What is the size of the money multiplier?
c. Suppose $5 million in new excess reserves appear in the banking system. How much will be created in the form of deposits and loans?
d. By how much did the leakages of funds from the banking system reduce the size of the transaction deposit multiplier? (Hint: compute the simple transaction deposit multiplier).
e. If the Fed purchases $175 billion worth of government securities on the open market, what is the effect on the money supply?