Reserve Ratio

Question 1


2. Assume that the Fed purchases a security for $500,000 from FirstBank. Also assume that the reserve ratio is 0.2 (20%).

FirstBank lends its excess reserves to Betty, who does her banking at SecondBank.
SecondBank lends its excess reserves to Charlie, who does his banking at ThirdBank.
ThirdBank lends its excess reserves to Donna, who does her banking at FourthBank.
Assume a simple money creation model, with no cash drain, no time deposits, and banks desire to hold no excess reserves.
How does the open market purchase affect the final T-accounts for FirstBank, SecondBank and ThirdBank? What is the total increase in deposits that results from the initial change in reserves?

3. Assume a model where the currency ratio is 0.2 (c = 0.2), the excess reserve ratio is 0.2 (e = 0.2), and the required reserve ratio is 0.2 (r = 0.2). What is the money multiplier? What change in the money supply results from an open market sale of $200,000?

4. Using the model of the market for reserves presented in Class 15, please show how the Fed can use open market operations to maintain the target for the federal funds rate. (HINT: In Microsoft Word, you can use the drawing toolbar to create lines to draw graphs.)

6.In the IS/LM model, what are the effects of an increase in the money supply? Show graphically and explain. When is monetary policy more effective, when the LM curve is relatively flat, or when the LM curve is relatively steep? Explain

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