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ECON 2 Lecture Notes - Lecture 7: Classical Dichotomy, Reserve Requirement, Federal Reserve System

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orangemarten224
17 Jun 2020
School
ELAC
Department
Economics
Course
ECON 2
Professor
Zhang

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Document Summary

Power is held by board of governors. Majority of funds are not kept on hand but rather loaned out. If a bank is only holds a certain percentage of reserves they can potentially run out of money before they run out of deposits. Can put a well off bank out of business. The feds manage the money supply also focused on targeting an interest rate. Banks can borrow reserves from the fed at an interest rate known as the discount rate: can change the reserve ratio, the higher interest rate the feds give the less incentive banks have to lend. The rate banks charge each other for short term loans (overnight) of reserves: extremely low since financial crisis. It cannot control how much currency the public holds relative to deposits. It sets min required reserves but banks can hold more. Leverage ratio- the ratio of assets to owners" equity.

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Related Questions

Assume that banks do not hold excess reserves and that households do not hold currency, so the only form of money is demand deposits. To simplify the analysis, suppose the banking system has total reserves of $400. Determine the money multiplier and the money supply for each reserve requirement listed in the following table.

Reserve Requirement Simple Money Multiplier Money Supply
(Percent) (Dollars)
20    
10    

A higher reserve requirement is associated with a money supply.

Suppose the Federal Reserve wants to increase the money supply by $200. Again, you can assume that banks do not hold excess reserves and that households do not hold currency. If the reserve requirement is 10%, the Fed will use open-market operations to worth of U.S. government bonds.

Now, suppose that, rather than immediately lending out all excess reserves, banks begin holding some excess reserves due to uncertain economic conditions. Specifically, banks increase the percentage of deposits held as reserves from 10% to 25%. This increase in the reserve ratio causes the money multiplier to to . Under these conditions, the Fed would need to worth of U.S. government bonds in order to increase the money supply by $200.

Which of the following statements help to explain why, in the real world, the Fed cannot precisely control the money supply? Check all that apply.

  1. The Fed cannot control the amount of money that households choose to hold as currency.
  2. The Fed cannot prevent banks from lending out required reserves.
  3. The Fed cannot control whether and to what extent banks hold excess reserves.

1. In a system of fractional-reserve banking, even without any action by the central bank, the money supply declines if households choose to hold (less, more) currency or if banks choose to hold (less, more) excess reserves.

2. If the Fed makes an open-market purchase of government bonds, it will (decrease, increase) the money supply. Whereas if there is an increase in the discount rate on Fed lending, it will (decrease, increase) the money supply.

3. Chloe takes $100 of currency from her wallet and deposits it into her checking account. If the bank adds the entire $100 to reserves, the money supply(decreases, doesn't change, increases), but if the bank lends out some of the $100, the money supply (decreases, doesn't change, increases).

4. If the reserve ratio is 0.25 and the central bank increases the quantity of reserves in the banking system by $120, the money supply increases by how much?

 

1. (0.2 pt) In a system of fractional-reserve banking, even without any action by the central bank, the money supply declines if households choose to hold (less, more) currency or if banks choose to hold (less, more) excess reserves. 

2. (0.2 pt) If the Fed makes an open-market purchase of government bonds, it will (decrease, increase) the money supply. Whereas if there is an increase in the discount rate on Fed lending, it will (decrease, increase) the money supply. 

3. (0.2 pt) Chloe takes $100 of currency from her wallet and deposits it into her checking account. If the bank adds the entire $100 to reserves, the money supply (decreases, doesn't change, increases), but if the bank lends out some of the $100, the money supply (decreases, doesn't change, increases). 

4.(0.2 pt) If the reserve ratio is 0.25 and the central bank increases the quantity of reserves in the banking system by $120, the money supply increases by how much? (Make sure to show all your work.)