Pretend you are in charge of conducting monetary policy at t

Pretend you are in charge of conducting monetary policy at the New York Fed and you have the following initial conditions. Initial Conditions rr/D = .10 C = 800 billion D = 1600 billion ER = 0 M = C + D Given the above information i) Calculate the MB. ii) Calculate the money multiplier (mm). iii) What is the money supply (use MS = mm x MB)?

Solution

(i)

Reserve ratio (rr) = 0.10

Deposit (D) = 1600 billion

Currency (C) = 800 billion

ER = 0

Calculate MB -

MB = C + (rr*D) + ER

MB = 800 billion + (0.10 * 1600 billion) + 0 billion = 800 billion + 160 billion = 960 billion

The MB is 960 billion.

(ii)

Currency ratio (c) = Currency/Deposit = 800 billion/1600 billion = 0.5

Required reserves ratio (rr) = 0.10

Calculate the money multiplier (mm) -

mm = (1+c)/(c+rr) = (1+0.5)/(0.5+0.10) = 1.5/0.6 = 2.5

The money multiplier (mm) is 2.5

(iii)

Calculate the money supply -

MS = mm * MB = 2.5 * 960 billion = 2400 billion

The money supply is 2400 billion.