BU204 02 Langhoff Melissa Unit7

Topics: Monetary policy, Federal Reserve System, Central bank Pages: 6 (954 words) Published: March 10, 2015

Unit 7 Assignment
BU204_02

Melissa Langhoff

Unit 7 Assignment
1 This section deals with increase money supply given two scenarios (see “a” and “b” below).

In Westlandia, the public holds 50% of money one (M1) in the form of currency, and the required reserve ratio is 20%. a Estimate how much the money supply will increase in response to a new cash deposit of $500 by completing the accompanying table.

Answer: Deposits will increase by $833.25 and the loans will expand by $666.60 meaning that the supply of money will increase. The currency however will be about $333.30 after all 10 rounds.

(Hint: The first row shows that the bank must hold $100 in minimum reserves — 20% of the $500 deposit — against this deposit, leaving $400 in excess reserves that can be loaned out. However, since the public wants to hold 50% of the loan in currency, only $400 × 0.5 = $200 of the loan will be deposited in round 2 from the loan granted in Round 1.) Round

Deposits
Required reserves
Excess reserves
Loans
Loan proceeds held as currency
Loan proceeds deposited
1
$500.00
$100.00
$400.00
$400.00
$200.00
$200.00
2
$200.00
40.00
160.00
160.00
80.00
80.00
3
80.00 
 16.00
64.00 
 64.00
 32.00
 32.00
4
 32.00
 6.40
 25.60
 25.60
 12.80
 12.80
5
 12.80
 2.56
 10.24
 10.24
 5.12
 5.12
6
 5.12
 1.02
 4.10
 4.10
 2.05
 2.05
7
 2.05
 .41
 1.64
 1.64
 .82
 .82
8
 .82
 .16
 .66
 .66
 .33
 .33
9
 .33
 .07
 .26
 .26
 .13
 .13
10
 .13
.03 
 .10
.10 
 .05
 .05

 
 
 
 
 
 
Totals
 833.25
166.65
666.60 
666.60 
333.30 
333.30 

b) How does your answer compare to an economy in which the total amount of the loan is deposited in the banking system and the public does not hold any of the loans in currency? (Hint: Complete the table below when none of the loan proceeds held in currency following the example for row 1.) Answer: Compared to the previous economy the deposits and the amount of currency in circulation would increase. The total deposits would increase by $1,398.32 compares to the previous chart and the proceeds would have increased by $1,451.96 at the end of the 10 rounds. Round

Deposits
Required reserves
Excess reserves
Loans
Loan proceeds held as currency
Loan proceeds deposited
1
$500.00
$100.00
$400.00
$400.00
0.00
$400.00
2
$400.00
80.00
320.00
320.00
0.00
320.00
3
 320.00
 64.00
 256.00
 256.00
 0
 256.00
4
 256.00
 51.20
 204.80
 204.80
 0
 204.80
5
 204.80
 40.96
 163.84
 163.84
 0
 163.84
6
 163.84
 32.77
 131.07
 131.07
 0
 131.07
7
 131.07
 26.21
 104.86
 104.86
 0
 104.86
8
 104.86
 20.97
 83.89
 83.89
 0
 83.89
9
 83.89
 16.78
 67.11
 67.11
 0
 67.11
10
 67.11
 13.42
 53.69
 53.69
 0
 53.69

 
 
 
 
 
 
Totals
2231.57 
417.31 
1785.26 
1785.26 
0.00 
1785.26 

c) What does this imply about the relationship between the public’s desire for holding currency and the money multiplier? Which scenario will contribute more to increase in money supply? Answer: The more money the public holds on to the lower supply of money. This will lead to a decrease in size of the money multiplier. Scenario B will lead to a increase in money supply because the public does not possess the currency.

2 Explain how each of the following changes quantity of money (money supply) in the economy.

a.
the Fed buys bonds: This will increase the money supply because the Fed are purchasing bonds and providing more cash in to the economy. b.
the Fed auctions credit: Auctioning credit allows banks to borrow money below the discount rate meaning that the money they borrow costs them less allowing them the ability to loan additional money to consumers. c.

the Fed raises the discount rate: This will cause a decrease in the loanable money. This is because it will cost the banks more to borrow the money, increased costs to the banks mean not at much money offered. d....

References: Mankiw, N. Principles of Macroeconomics. 7th Edition. Cengage Learning, 2015
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