Question

Refer to the table below and assume that the Feds reserve ratio is 10 percent and the economy is in a severe recession. Also suppose that the commercial banks are hoarding all excess reserves (not lending them out) because of their fear of loan defaults. Finally, suppose that the Fed is highly concerned that the banks will suddenly lend out these excess reserves and possibly contribute to inflation once the economy begins to recover and confidence is restored.

a. By how many percentage points would the Fed need to increase the reserve ratio to eliminate one-third of the excess reserves?___________ %.

b. What would be the size of the monetary multiplier before the change in the reserve ratio? ___________

Instructions: Round your answers to 2 decimal places.

   

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What would be the size after the change? .

___________

c. By how much would the lending potential of the banks decline as a result of the increase in the reserve ratio? $___________.

Answer 1

a) From the given table, the fed reserve ratio is 10% and the amount of excess reserves is $3,000. If the fed wants to reduce a one third of this excess reserve and eliminate $1,000 of excess reserves, then it leads to should raise the reserve ratio to 15%. This will result in excess reserve ofS2,000 Thus, the percentage of fed raise the reserve ratio is 5%. b.) Money multiplier: Money multiplier can be calculated by using the following formula: Money multiplier- Required reserve ratio The monetary multiplier before the change can be calculated as follows: Multiplier before change = 0.1 - 10 Thus, the value of monetary multiplier before the change is 10. The monetary multiplier after the change can be calculated as follows: Multiplier after change- 0.15 6.67 Thus, the value of monetary multiplier after the change is 6.67.

C) Bank lending potential: Banking lending potential can be calculated as follows: Bank lending potential-Money multiplierx Excess reserves Before the change, the bank lending potential can be calculated as follows: Bank lending potential-Money multiplierx Excess reserves -10x 3,000 -30,000 Thus, the value of bank lending potential before the change is S30,000 After the change, the bank lending potential can be calculated as follows: Bank lending potential-Money multiplierx Excess reserve:s -6.67 x2,000 13,340 Thus, the value of bank lending potential after the change is S13,340 Hence, the value of decline in lending is S16,600 (30,000-13,340