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Money creation process
Banks in New Transylvania have a desired reserve ratio of 10 percent of deposits and no excess reserves. Households want to keep 25% of their money as currency. Now suppose that the Central Bank increases the monetary base by $1,000 billion.
a) How much do the banks lend in the first round of the money creation process?
b) How much of the initial amount lent flows back to the banking system as new deposits?
c) How much do the banks lend in the second round of the money creation process?
d) Show with the help of a graph what happens to the interest rate as a result of the increase in the monetary base by the Central Bank. (No actual numbers needed)
e) In the long run, what is going to happen to the price level when the monetraty base increases and the economy is at full capacity?
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