Suppose the commercial banks keep no excess reserves, and people deposit all their money they receive into the banking system. Suppose the required reserve ratio is 0.05 (5%). Suppose the Federal Reserve wants to increase the monetary base by $2,000,000.
a) How will the Fed most likely do this?
b) Show how this will affect the bank with whom the Fed transacts
c) Next, show how the money expansion process will affect the balance sheets of two more commercial banks, showing the change in the overall money supply at each step
d) In total, how much did money supply change as a result of the Fed’s actions. (Hint: Use the simple money multiplier)
e) How much would money supply change as a result of the Fed’s action if banks held an additional 5% of cash reserves?
f) Now suppose that in addition to the 5% of excess bank reserves from part (e) we assume that individuals and firms hold 10% of their money in cash versus checking deposits, how much would money supply change as a result of the Fed’s action