Reference no: EM132460729

Suppose the Fed executes a open market purchases of government bonds in the amount of $85 billion. Before this transaction, all banks satisfied their reserve requirements and held no excess reserves. The required reserve ratio is 10%.

a. Assume that people do not hold any currency, there are zero excess reserves, and that the $85B was initially deposited into a single bank. How much of the $85B might we expect the bank to lend out?

b. Now suppose we include currency in the money supply and that the currency-to-deposit ratio is 50%. Use the M1 money multiplier to calculate the ultimate addition to money in the economy from the original $85B open market operations.

c. From your answer to part b, what would be the expected change in total lending associated with the $85B open market operations? What would be the expected change in the monetary base?

d. What will be the ultimate addition to money in the economy from the original $85B open market operations if the reserve ratio is 10%, the currency-to-deposit ratio is 50%, AND banks hold 5% excess reserves? Is this amount more or less than what you found in part b? What behavior explains the difference?