Chapter 15: The Money Supply Process

Exercise Questions
Monetary Economics
Muhammad Sannan
ANSWER: 1

a. You get a $10,000 loan from the bank to buy an automobile.

 For You (Depositor): Liability (You owe the bank $10,000).

 For the Bank: Asset (They hold a $10,000 loan receivable).

b. You deposit $400 into your checking account at the local bank.

 For You (Depositor): Neither (Your deposit is an asset for you, but it's not a liability).
 For the Bank: Liability (They owe you $400, which is a deposit).

c. The Fed provides an emergency loan to a bank for $1,000,000.

 For the Federal Reserve: Asset (They hold the bank's promise to repay the loan).
 For the Bank: Liability (They owe the Federal Reserve $1,000,000).

d. A bank borrows $500,000 in overnight loans from another bank.

 For the Borrowing Bank: Liability (They owe the other bank $500,000).
 For the Lending Bank: Asset (They hold the other bank's promise to repay $500,000).

e. You use your debit card to purchase a meal at a restaurant for $100.

 For You (Depositor): Neither (Your checking account balance decreases, but there is no
direct creation of assets or liabilities in this transaction).
 For the Bank: Neither (The bank's liabilities (your deposit) are reduced, but there's no
direct impact on their assets or liabilities in this specific transaction).
 ANSWER: 2

The process of deposit creation in the banking system is determined by the money
multiplier, which is a function of the reserve requirement set by the central bank. The
formula for the money multiplier is:

Money Multiplier=1/Required Reserve Ratio

If the First National Bank receives an extra $100 in reserves and decides not to lend out
any of these reserves, the money multiplier will not come into play because the reserves
are not being used to create new loans and deposits.

In this scenario, the deposit creation for the entire banking system is zero since the
reserves are not multiplied through the lending process. The money multiplier only
affects deposit creation when banks use excess reserves to make new loans, leading to a
multiplication of the initial reserve injection.

ANSWER: 3
When the Federal Reserve buys $1 million worth of bonds from the First National Bank,
it injects $1 million in reserves into the banking system. If the First National Bank and
other banks use the resulting increase in reserves to purchase securities (such as more
bonds) and not to make loans, the impact on checkable deposits will be limited.

1. Fed Buys Bonds from First National Bank:

 The Federal Reserve buys $1 million worth of bonds from the First National Bank.
 The Fed credits the reserve account of First National Bank with $1 million.
2. Increase in Reserves:
 First National Bank now has an additional $1 million in reserves.
3. Banks Purchase Securities:
 If First National Bank and other banks use these reserves to purchase securities
(bonds, for example), it doesn't directly impact checkable deposits. The banks are
exchanging one type of asset (reserves) for another (securities).
4. No Change in Checkable Deposits:
 Since the reserves are not used to make loans or create new checkable deposits,
there is no immediate impact on the overall level of checkable deposits in the
banking system.

ANSWER: 4
1. Reserves:
 Reserves are the deposits that banks hold at the central bank (Federal Reserve in
the U.S.) plus vault cash.
 When the depositor withdraws $1,000 in currency, the bank's reserves decrease
by $1,000 because the currency is no longer part of the bank's reserves.
2. Checkable Deposits:
 Checkable deposits represent the money that depositors have in their accounts,
which they can access through checks or electronic transactions.
 When the depositor withdraws $1,000 in currency, the checkable deposits
decrease by $1,000.
3. Monetary Base:
 The monetary base is the sum of currency in circulation (outside the banking
system) and reserves held by banks.
 The withdrawal of $1,000 in currency reduces the reserves (part of the monetary
base) by $1,000.
 However, the currency in circulation increases by $1,000 since the withdrawn
money is now in the hands of the depositor.

ANSWER: 5
When a bank sells $10 million of bonds to the Federal Reserve to pay back a $10 million
loan, it involves several steps that have implications for the level of checkable deposits.
Let's break down the process:

1. Bank Sells Bonds to the Fed:

 The bank sells $10 million worth of bonds to the Federal Reserve.
 In return, the Federal Reserve credits the bank's reserve account with $10 million.
2. Loan Repayment:
 The bank uses the $10 million it received from selling bonds to the Fed to repay
its $10 million loan.

Now, let's examine the impact on checkable deposits:

 No Direct Impact on Checkable Deposits:

 The transaction of selling bonds and repaying the loan does not directly impact
checkable deposits. Checkable deposits are not involved in this specific
transaction.
 Indirect Impact Potential:
 The indirect impact on checkable deposits would depend on what the bank does
next. If the bank chooses to hold excess reserves, it might not have a direct
impact on checkable deposits. However, if the bank decides to use the $10
 million to make new loans, it could potentially lead to an increase in checkable
deposits through the money creation process

ANSWER: 6

When you decide to hold $100 less cash and deposit that $100 in the bank, the effect on
checkable deposits in the banking system will be a net increase. Here's how it works:

1. You Hold $100 Less Cash:

 Your decision to hold $100 less in cash means that you have an additional $100
that you are willing to deposit in the bank.
2. Deposit in the Bank:
 By depositing $100 in the bank, your checkable deposit account increases by
$100.
3. Overall Impact on the Banking System:
 Your action contributes to an increase in total checkable deposits in the banking
system by $100.

ANSWER: 7
The statement "The Fed can perfectly control the amount of reserves in the system" is
generally false. While the Federal Reserve has tools and mechanisms to influence the
level of reserves in the banking system, achieving perfect control is challenging due to
several factors:

1. Autonomous Factors: The Fed does not have control over all factors influencing
reserves. Autonomous factors, such as changes in currency holdings by the public or
fluctuations in the Treasury's account with the Fed, can impact reserves independently
of the Fed's actions.
2. Open Market Operations: The Fed primarily uses open market operations (buying or
selling government securities) to influence the level of reserves. However, the impact is
not always perfectly predictable due to various market dynamics and participants'
reactions.
3. Interest Rate Movements: The Fed's target interest rates (like the federal funds rate)
also influence the demand for reserves. However, the relationship between interest rates
and reserve demand is complex and subject to changes in economic conditions.
4. Bank Behavior: Banks' decisions regarding lending, borrowing, and holding reserves
are influenced by various factors, including economic conditions, regulations, and risk
considerations. The Fed can provide incentives or disincentives, but it cannot perfectly
control individual bank behavior.
5. Market Dynamics: The financial markets and global economic conditions can introduce
uncertainties that impact the effectiveness of the Fed's actions in controlling reserves.

ANSWER: 8
The statement "The Fed can perfectly control the amount of the monetary base, but has
less control over the composition of the monetary base" is generally true. Let's break
down the statement:

1. Control over the Amount of the Monetary Base:

 The monetary base, also known as high-powered money or the money supply's
narrowest component, consists of currency in circulation and bank reserves (both
required and excess reserves).
 The Federal Reserve has the ability to control the total amount of the monetary
base through various tools, such as open market operations, discount rate
changes, and reserve requirements.
2. Less Control over the Composition of the Monetary Base:
 While the Fed can influence the total amount of the monetary base, it has less
direct control over the composition of the components. For example, the
composition includes currency in circulation, which is influenced by public
preferences for holding cash, and bank reserves, which depend on banks'
decisions regarding lending and holding reserves.
 Changes in the composition of the monetary base may be influenced by factors
beyond the direct control of the Federal Reserve, such as changes in the public's
demand for cash or shifts in banks' reserve management strategies.

ANSWER: 9
When the Federal Reserve buys $100 million worth of bonds from the public and lowers
the required reserve ratio, it is likely to have an expansionary effect on the money
supply. Let's break down the process:

1. Fed Buys Bonds from the Public:

 The Fed purchases $100 million worth of bonds from the public. In this
transaction, the Fed credits the sellers' bank reserves with $100 million.
2. Increase in Bank Reserves:
 The $100 million increase in bank reserves allows banks to lend more money.
3. Lowering the Required Reserve Ratio:
 If the Fed lowers the required reserve ratio, banks are required to hold a smaller
percentage of their deposits as reserves. This means they can lend out a larger
portion of the new reserves.
4. Money Creation Through Lending:
  Banks use the increased reserves to make new loans. As these loans are
deposited in other banks, the money supply expands through the money creation
process.
5. Multiple Rounds of Lending:
 The process can continue through multiple rounds of lending, further increasing
the money supply as the newly created deposits are used to make additional
loans.

ANSWER: 10
a) Central Bank (e.g., Federal Reserve):

 Open Market Operations: The central bank can buy or sell government securities in the
open market. When the central bank buys securities, it injects money into the banking
system, increasing reserves and potentially leading to more lending and money creation.
Conversely, selling securities absorbs money, reducing reserves and potentially limiting
lending.
 Discount Rate: The central bank can influence the money supply by changing the
discount rate, the interest rate at which banks borrow from the central bank. Lowering
the discount rate encourages borrowing, leading to more lending and increased money
supply.
 Reserve Requirements: Adjusting the required reserve ratio can directly impact the
money supply. Lowering the reserve requirements allows banks to lend a higher
proportion of their deposits, leading to an increase in the money supply.

(b) Banks:

 Lending Behavior: Banks play a crucial role in money creation through the lending
process. When banks make loans, they create new deposits, contributing to the
expansion of the money supply. Conversely, if banks reduce lending, the money supply
can contract.
 Reserve Management: Banks' decisions on how much to hold in reserves versus lending
out affect the overall money supply. If banks choose to hold excess reserves, the money
supply may not expand as much. Conversely, if they lend out more of their reserves, the
money supply can increase.

(c) Depositors (General Public):

 Currency Holding: If depositors decide to hold more currency and less in deposit
accounts, the money supply may decrease as currency is not part of the bank's reserves.
 Deposit Behavior: Depositors can influence the money supply by their deposit and
withdrawal decisions. When depositors deposit money into banks, it contributes to the
money supply. Conversely, withdrawing funds reduces the money supply.
 Use of Credit: Depositors using credit (taking out loans) contribute to the money supply
by creating new deposits. This is because the borrowed funds are deposited in the
banking system, leading to an increase in the money supply.

ANSWER: 11
The statement "The money multiplier is necessarily greater than 1" is generally true. The
money multiplier is a measure of the potential increase in the money supply resulting
from an initial change in the quantity of reserves in the banking system. The formula for
the money multiplier is:

Money Multiplier=1/Required Reserve Ratio

The required reserve ratio represents the fraction of deposits that banks are required to
hold as reserves. Since the denominator in the money multiplier formula is the required
reserve ratio, the money multiplier will be greater than 1 if the required reserve ratio is
less than 1.

Here's why:

1. If the required reserve ratio is 0.1 (10%), the money multiplier would be 1/0.1=10.
2. If the required reserve ratio is 0.05 (5%), the money multiplier would be 1/0.05=20.

In both cases, the money multiplier is greater than 1. This implies that an initial injection
of reserves into the banking system can lead to a multiple expansion of the money
supply through the lending and deposit creation process.

It's important to note that the money multiplier is a theoretical concept, and in practice,
various factors can influence the actual multiplier, including the behavior of banks and
the public, changes in the velocity of money, and other economic conditions.

ANSWER: 12
A financial panic can have a significant impact on the money multiplier and the money
supply, often leading to a contraction in the broader monetary system. Here's how a
financial panic may affect these factors:

1. Reduced Confidence and Bank Runs:

  During a financial panic, there is a heightened sense of uncertainty and fear
among depositors. This can lead to bank runs, where a large number of
depositors simultaneously withdraw their funds due to concerns about the
stability of banks.
2. Increased Demand for Currency:
 In times of panic, individuals may prefer to hold physical currency rather than
keeping their money in banks. This increased demand for currency can lead to a
reduction in checkable deposits in the banking system.
3. Decreased Bank Reserves:
 Bank runs and widespread withdrawals result in a reduction of bank reserves. As
depositors withdraw funds, banks must use their reserves to meet these
demands. This lowers the overall reserve levels in the banking system.
4. Contractions in Lending:
 Banks facing a reduction in reserves and increased uncertainty may become more
cautious and conservative in their lending practices. This contraction in lending
limits the creation of new deposits through the lending and deposit
multiplication process.
5. Impact on the Money Multiplier:
 The money multiplier, which is inversely related to the required reserve ratio, may
decrease during a financial panic. If banks increase their reserve ratios in
response to heightened uncertainty, the money multiplier will be lower.
6. Overall Contraction in the Money Supply:
 The combination of reduced bank reserves, decreased lending, and increased
demand for currency often results in an overall contraction in the money supply.
The panic-induced reduction in deposit creation through the lending process
contributes to a decrease in the broader monetary aggregates.

ANSWER: 13
The money multiplier is influenced by two main factors: the currency ratio (c) and the
excess reserves ratio (e). The formula for the money multiplier is:

Money Multiplier=1/Required Reserve Ratio

The required reserve ratio is determined by subtracting the currency ratio and the
excess reserves ratio from 1:

During the Great Depression years from 1930 to 1933, it's reported that both the
currency ratio (c) and the excess reserves ratio (e) rose dramatically. Let's analyze the
impact of these changes on the money multiplier:
1. Currency Ratio (c):
 If the currency ratio (c) increases, it means that a larger proportion of the money
supply is held in the form of currency rather than as demand deposits. An
increase in c decreases the value of (1 - c - e), which, in turn, increases the
required reserve ratio.
2. Excess Reserves Ratio (e):
 If the excess reserves ratio (e) rises, it means that banks are holding a larger
proportion of their reserves in excess rather than lending them out. An increase
in e also increases the required reserve ratio.

Given that both c and e increased dramatically during the Great Depression, the
combined effect would likely be a significant increase in the required reserve ratio. As a
result, the money multiplier, which is the reciprocal of the required reserve ratio, would
decrease.

ANSWER: 14
Paying interest on excess reserves is a monetary policy tool that the Federal Reserve can
use to influence the behavior of banks. By doing so, the Fed aims to impact the money
supply and control inflation. The introduction of interest on excess reserves can affect
the multiplier process and the money supply in several ways:

1. Increased Incentive for Banks to Hold Excess Reserves:

 Paying interest on excess reserves provides banks with an incentive to hold more
reserves rather than lending them out. Since banks can earn interest on their
excess reserves held at the Federal Reserve, they might be less inclined to engage
in the lending and money creation process.
2. Reduced Lending and Deposit Creation:
 When banks hold excess reserves and are less eager to lend, the money creation
process through the deposit multiplier effect is weakened. As a result, there may
be less expansion of the money supply compared to a scenario where banks are
actively lending.
3. Effect on the Money Multiplier:
 The money multiplier is inversely related to the required reserve ratio. When the
Fed pays interest on excess reserves, banks may choose to hold more reserves
voluntarily, increasing the effective reserve ratio. This can lead to a decrease in
the money multiplier.
4. Potential Impact on Overall Money Supply Growth:
 If banks prefer to hold excess reserves due to the interest paid by the Fed, the
overall growth of the money supply may be slower. The incentive for banks to
 lend and create new deposits is reduced, limiting the expansion of broad money
aggregates.
5. Adjustment of Monetary Policy:
 The interest on excess reserves rate can be used by the Fed as a tool to
implement and adjust monetary policy. By changing the rate, the Fed can
influence the behavior of banks and fine-tune the balance between inflation
control and promoting economic activity

ANSWER: 15
The decline in the money multiplier during the periods 1930–1933 and 2008–2010,
despite different outcomes in M1 money supply, can be attributed to changes in various
factors influencing the money creation process and the behavior of banks and the
public. Several key factors help explain the difference in outcomes between the two
periods:

1. Interest on Reserves:
 During the recent financial crisis (2008–2010), the Federal Reserve introduced the
payment of interest on reserves. This policy aimed to encourage banks to hold
excess reserves at the Fed rather than lending them out. This had the effect of
reducing the money multiplier by limiting the deposit creation process.
 In contrast, during the 1930s, interest on reserves was not paid. The difference in
the treatment of reserves played a role in shaping the behavior of banks and their
lending activities.
2. Banking System Stability:
 The stability of the banking system also matters. In the 1930s, the banking system
faced widespread failures and a lack of confidence, leading to a contraction in
lending and a decrease in the money supply.
 During the 2008 financial crisis, there were significant interventions by central
banks and governments to stabilize the financial system. Policymakers took steps
to prevent widespread bank failures and restore confidence, which helped
prevent a severe contraction in the money supply.
3. Velocity of Money:
 The velocity of money, representing the speed at which money circulates in the
economy, can impact the effectiveness of changes in the money supply. A change
in the velocity of money can offset the impact of changes in the money supply on
nominal GDP.
  In the recent financial crisis, despite the decline in the money multiplier, increased
spending velocity and demand for money contributed to an overall increase in
the M1 money supply.
4. Quantitative Easing and Asset Purchases:
 During the 2008–2010 period, central banks, including the Federal Reserve,
implemented unconventional monetary policies such as quantitative easing. This
involved large-scale purchases of financial assets to increase bank reserves and
stimulate economic activity.
 The asset purchases had an impact on the broader financial markets and
contributed to an expansion of certain components of the money supply, even as
the money multiplier declined.
5. Policy Responses:
 The responses of central banks and governments to economic crises play a
crucial role. The policy responses during the recent financial crisis were more
proactive, with measures taken to stabilize financial institutions and provide
liquidity support to prevent a severe contraction in the money supply.

ANSWER: 16

If the Fed sells $2 million of bonds to the First National Bank

First National Bank

Assets Liabilities
Reserves -$2 million

Securities +$2 million

Federal Reserve System

Assets Liabilities
Securities -$2 million Reserves -$2
million

Explanation:
When the Federal Reserve sells $2 million of bonds to the First National Bank, it receives
$2 million in reserves in exchange. This transaction increases the reserves held by the
Fed while decreasing its holdings of bonds. Conversely, the First National Bank
experiences a decrease in reserves by $2 million and an increase in its bond holdings by
the same amount. Overall, the transaction results in a $2 million reduction in reserves
within the banking system. However, since the sale of bonds offsets the increase in
reserves, there is no change in the monetary base.

ANSWER: 17

(a) The central bank provides loan to commercial bank.

Central Bank

Assets Liabilities

Loans +$10 million Reserves +$10

million

Commercial Bank

Assets Liabilities

Reserves -$10 million Loans +$10

million

Explanation:
The central bank provides a $10 million loan to the commercial bank, increasing its
loans asset. Simultaneously, the commercial bank's reserves increase by $10 million,
corresponding to the loan received. Both the central bank's and commercial bank's
reserves and assets increase by $10 million each, leading to no change in the monetary
base.

(b) The central bank sells securities to the commercial bank.

 Central Bank

Assets Liabilities

Reserves +$10 million Securities -$10

million

Commercial Bank

Assets Liabilities

Securities -$10 million Reserves +$10

million

Explanation:
The central bank sells $10 million in securities to the commercial bank, decreasing its
securities asset. As a result, the commercial bank's reserves decrease by $10 million,
representing the payment for the securities. Both the central bank's and commercial
bank's reserves and assets remain unchanged, resulting in no change in the monetary
base.

(c) The commercial bank repays the loan to the central bank.

Central Bank

Assets Liabilities

Loans -$10 million Reserves -$10

 million

Commercial Bank

Assets Liabilities

Reserves -$10 million Loans -$10

million

Explanation:
The commercial bank repays the $10 million loan to the central bank, reducing its loans
asset. Consequently, the commercial bank's reserves decrease by $10 million, reflecting
the repayment of the loan. Both the central bank's and commercial bank's reserves and
assets decrease by $10 million each, resulting in no change in the monetary base.

ANSWER: 18

The Fed lends $100 million to five banks:

Federal Reserve System

Assets Liabilities

Loans +$100 million Reserves +$100

million
 Bank (all five banks)

Assets Liabilities

Reserves +$100 million Loans +$100

million

Depositor

Assets Liabilities

No change No change

After the depositor withdraws $50 million to hold as currency:

Federal Reserve System

Assets Liabilities

Loans +$100 million Reserves +$50

million

Currency +$50
 million

Bank (all five banks)

Assets Liabilities

Reserves +$100 million Loans +$100

million
Checkable Deposits -$50
million

Depositor

Assets Liabilities

Checkable Deposits -$50 million

Currency +$50 million

Explanation:
Initially, the Federal Reserve lends $100 million to five banks, increasing reserves and
loans by $100 million each. When depositors withdraw $50 million and hold it as
currency, deposits decrease by $50 million, leading to a decrease in reserves held by
banks by the same amount. Overall, reserves remain unchanged, but the monetary base
decreases by $50 million due to the withdrawal of currency by depositors.
ANSWER: 19

The initial impact of the loans extended by the Fed is shown in the T-accounts below:

Federal Reserve System

Assets Liabilities

Loans +$1 million Reserves +$1

million

First National Bank

Assets Liabilities

Reserves +$1 million Loans +$1

million

Upon receiving the reserves, banks proceed to lend out the excess reserves. This leads
to multiple deposit creation, where the increase in reserves within the banking system
supports $10 million in new loans and checkable deposits, resulting in a $10 million
expansion of the money supply. The culmination of this multiple deposit creation
process is depicted in the following T-accounts:

Federal Reserve System

 Assets Liabilities

Loans +$1 million Reserves +$1

million

First National Bank

Assets Liabilities

Reserves +$1 million Loans +$1

million

Loans +$10 million Checkable Deposits +$10

million

Explanation:
Before the transaction, the First National Bank has checkable deposits in its account.
After the Fed lends $1 million to the First National Bank, the bank's reserves and
checkable deposits increase by $1 million each, as it receives the loan amount. This
increase in checkable deposits contributes to the overall checkable deposits in the
banking system.

ANSWER: 20

The Federal Reserve's sale of bonds to the First National Bank decreases reserves by $2
million. Consequently, checkable deposits in the banking system decrease by $20
million. The initial impact on both the Federal Reserve and the banking system is
illustrated below:
 Federal Reserve System

Assets Liabilities

Securities -$2 million Reserves -$2

million

First National Bank

Assets Liabilities

Securities +$2 million

Reserves -$2 million

Following the reduction in bank reserves, the process of multiple deposit creation
operates in reverse. As a result, the ultimate impact on the balance sheets of both the
Federal Reserve and the banking system is depicted below:

Federal Reserve System

Assets Liabilities

Securities -$2 million Reserves -$2

million
 First National Bank

Assets Liabilities

Securities +$2 million Checkable Deposits -$20

million

Reserves -$2 million

Loans -$20 million

ANSWER: 21

The total increase in checkable deposits is only $5 million, substantially less than the $10
million that occurs when no excess reserves are held. The reason is that banks now end
up holding 20% of deposits as reserves and only lend out 80%, so that the increase in
deposits found in the T-accounts is $1,000,000 + $800,000 + $640,000 + $512,000 +
$409,600 + . . = $5 million. The T-accounts below show the effect of the securities
purchase:

Federal Reserve System

Assets Liabilities

Securities +$1 million Reserves +$1

million
 First National Bank

Assets Liabilities

Securities -$1 million

Reserves +$1 million

After the increase in reserves and the multiple deposit creation process, the Fed and
Banking system balance sheets are as follows:

Federal Reserve System

Assets Liabilities

Securities +$1 million Reserves +$1

million

First National Bank

Assets Liabilities

Securities -$1 million Checkable Deposits +$5

million

Reserves +$1 million

 Loans +$5 million

ANSWER: 22

The banking system is still not in equilibrium because there continues to be $100 million
of excess reserves (+$1 billion of reserves minus $900 million of required reserves, 10%
of the $9 billion of deposits). The excess reserves will be lent out until equilibrium is
reached with an additional $1 billion of checkable deposits. The T-account for the
banking system when it is in equilibrium is as follows:

Banking System

Assets Liabilities

Reserves +$1 billion Loans +$1

billion

Loans +$10 billion Checkable Deposits +$10

billion

ANSWER: 23

Checkable deposits will decrease by $50 million when the banking system is in equilibrium (as a
result of the $5 million decrease in reserves supporting the money supply). The T-account is
shown below:

Banking System
 Assets Liabilities

Reserves -$5 million Checkable Deposits -$50

million

Securities +$5 million

Loans -$50 million

ANSWER: 24

When the Fed sells $1 million of bonds and banks reduce their borrowings from the Fed
by $1 million, it leads to a decrease in the money supply. This occurs because the sale of
bonds by the Fed reduces the monetary base by $1 million. Additionally, the reduction
in borrowing from the Federal Reserve further decreases the monetary base by another
$1 million. Therefore, the total decline in the monetary base is $2 million, resulting in a
corresponding decrease in the money supply. This reduction in the money supply occurs
as both actions effectively remove money from circulation in the economy.

ANSWER: 25

a. The money supply (M) is the sum of currency (C) and checkable deposits (D), which is
$600 billion + $900 billion = $1500 billion. The currency deposit ratio (c) is calculated by
dividing currency by checkable deposits, resulting in 0.667. The excess reserve ratio (e) is
excess reserves (ER) divided by checkable deposits (D), yielding 0.017. The money
multiplier (m) is calculated using the formula (1 + c) / (rr + e + c), where rr is the
required reserve ratio. Given the provided excess reserve ratio and the currency deposit
ratio, the money multiplier is 2.13.
b. With the unusually large open market purchase of bonds by the central bank, the
monetary base increases by the amount of the purchase, leading to an increase in the
money supply. Using the calculated money multiplier from part (a), the new money
supply is projected to be $4483.65 billion.

c. If banks choose to hold all of the proceeds from the open market purchase as excess
reserves rather than loan them out, the excess reserves would increase to $1415 billion.
Consequently, the excess reserve ratio would rise to 1.57. However, since currency and
deposits remain the same, the money supply remains at $1500 billion. As a result, the
money multiplier decreases to 0.71.

d. The scenario described in part (c) is similar to the situation during the financial crisis
in 2008, where the Federal Reserve injected liquidity into the banking system, but
lending remained low. This led to a situation where the money multiplier was below 1
for an extended period, reflecting the possibility of large amounts of reserves entering
the banking system but being held as excess reserves, resulting in a decreased money
multiplier.