Suppose that, using past data, the staff of the Board of Governors of the Federal Reserve estimates the currency-to-deposit ratio equals 40 percent and the excess reserve-to-deposit ratio equals 6 percent. Suppose further that the average required reserve ratio is 10 percent. With increasing concerns about inflationary pressures, the FOMC considers the implementation of a more restrictive monetary policy by the end of 2015.
1. Using the multiplier model of the money supply process and the information provided by the Board of Governor’s staff, predict the impact of an open market sale of $100 million worth of U.S. Treasury securities on the following: (a) the money supply, M; (b) currency held by the non-bank public, C; and, (c) reserves, R.
2. Explain how and why you would modify your predictions (qualitatively) for the money supply (part 1.1a only) under each of the two following hypothetical scenarios. Treat each scenario separately. [20 points] (a) Effective next year, the Federal Reserve increases the interest paid on excess reserves. (b) The U.S. Congress passes legislation prohibiting the use of the toobig-to-fail policy under any circumstances, effective immediately.