Review Dollar value of Required Reserves = Amount of deposit X required reserve ratio Excess Reserves = Total Reserves – Required Reserves Maximum amount.

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Presentation transcript:

Review Dollar value of Required Reserves = Amount of deposit X required reserve ratio Excess Reserves = Total Reserves – Required Reserves Maximum amount a single bank can loan = the change in excess reserves caused by a deposit The money multiplier = 1/required reserve ratio Total Change in Loans = amount single bank can lend X money multiplier Total Change in the money supply = Total Change in Loans + $ amount of Fed action Total Change in demand deposits = Total Change in Loans + any cash deposited

The Money Multiplier and Multiple Deposit Expansion The money multiplier shows us the impact of a change in demand deposits on loans and eventually the money supply. To calculate the money multiplier, divide 1 by the required reserve ratio. Money multiplier = 1/ reserve ratio Ex. If the reserve ratio is 25%, then the multiplier = 1/ .25 = 4 Ex. If the reserve ratio is 10%, then the multiplier=1/.1=10

Types of Multiple Deposit Expansion Question Type 1: Calculate the initial change in excess reserves a.k.a. the amount a single bank can loan from the initial deposit Type 2: Calculate the change in loans in the banking system Type 3: Calculate the change in the money supply Sometimes type 2 and type 3 will have the same result (i.e. no Fed involvement) Type 4: Calculate the change in demand deposits

Example 1 Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the amount that a single bank can lend from this Federal Reserve purchase of bonds. The amount of new demand deposits – required reserve = The initial change in excess reserves $100 million – (20% * $100 million) $100 million – $20 million = $80 million in ER

Example 2 Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum change in loans in the banking system from this Federal Reserve purchase of bonds. The initial change in excess reserves * The money multiplier = max change in loans $80 million * (1/20%) $80 million * (5) = $400 million max in new loans

Example 3 Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum change in the money supply from this Federal Reserve purchase of bonds. The maximum change in loans + $ amount of Federal Reserve action $400 million + $100 million = $500 million max change in the money supply

Example 4 Given a required reserve ratio of 20%, assume the Federal Reserve purchases $100 million worth of US Treasury Securities on the open market from a primary security dealer. Determine the maximum change in demand deposits from this Federal Reserve purchase of bonds. The maximum change in loans + $ amount of initial deposit ER*money multiplier+$amount of initial deposit ($500*.8)=$400+$100 $400 million + $100 million = $500 million max change in demand deposits