Question

6- The SIMPLE financial system has these relationships: The ratio of reserves to total deposits is 12 percent, and the ratio of non-checkable deposits to checkable deposits is 40 percent. In addition, currency held by the nonbank public amounts to 15 percent of checkable deposits. The ratio of government deposits to checkable deposits is 8 percent, and the monetary base is $300 million. a. Determine the size of the MI money multiplier and the size of the money supply. b. If the ratio of currency in circulation to checkable deposits were to drop to 13 percent while the other ratios remained the same, what would be the impact on the money supply? . If the ratio of government deposits to checkable deposits increases to 10 percent while the other ratios remained the same, what would be the impact on the money supply?

Answer 1

a) Money Multiplier(m)=

(1 + k) [r(1+t+g) + k]

Here k= currency held by nonbank public amount in relation to checkable deposits

r=ratio of reserves to total deposits

t= ratio of non-checkable deposits to checkable deposits

g= ratio of government deposits to checkable deposits

Therefore, m= (1+.15)/[.12(1+.40+.08)+.15]

                        =1.15/0.3276

                        =3.51

            And, Size of the money supply = Monetary base * Money multiplier

                                                            =$300 million*3.51

                                                            =$1.053 Billion

b) Since K is changing to 13%;

Therefore new money multiplier(m) will be= (1+.13)/[.12(1+.40+.08)+.13]

                                                            =1.13/.3076

                                                            =3.67 or 3.7

Money supply= $300 million * 3.7= $1.11 billion

Therefore, the money supply increased =.06 billion or 60 million dollars

c) Since g is changing to 10%,

Therefore new money multiplier(m) will be= (1+.15)/[.12(1+.40+.10)+.15]

                                                            =1.15/.33

                                                            =3.48 or 3.5

Money supply= $300 million * 3.5=$1.05 billion

Therefore, money supply decrease slightly by $.003 billion

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