Question

Assume that the banking system has total reserves of $100 billion. Assume also that required reserves are 10 percent of checking deposits and that banks hold no excess reserves and households hold no currency

a. What is the money multiplier? What is the money supply?
b. If the Fed now raises required reserves to 20 percent of deposits, what are the change in reserves and the change in the money supply?

Answer 1

a. What is the money multiplier? What is the money supply?

• the money multiplier = 1 / reserve ratio = 1 / 10% = 10
• the money supply = $100 billion x 10 = $1,000 billion

b. If the Fed now raises required reserves to 20 percent of deposits, what are the change in reserves and the change in the money supply?

• the money multiplier = 1 / 20% = 5
• money supply = $100 billion x 5 = $500 billion
• the money supply will decrease by = $1,000 billion - $500 billion = $500 billion