Econ 325
Money and Banking
Answers to Problem Set 6
Note: these are only suggested answers to make sure you're on the right track. Expand upon them
as necessary from your class notes and your book.
I. Definitions
On your own. See your class notes and your book.
II. Short-Answer Questions/Essays/Calculations
1. Use the data given to calculate the currency to deposit ratio (c=C/D) and the excess reserve
ratio (e=ER/D) – notice that each of these are calculated using D, which is defined as checkable
deposits (not savings accounts or other time deposits). Then use c, e, and rr in the equation for
the M1 multiplier (the complex money multiplier) to get that the money multiplier is 3.
(Additional hint: what if I asked for the M2 multiplier? what further information would you
need?)
2. (a) Assets: Reserves = 18.9, Loans = 150.0, Securities = 31.3; Liabilities: Checkable Deposits
= 180.0; Net worth: 20.2. RR=0.03(30)+0.12(150)=18.9. ER=0.
(b) Assets: Reserves=23.9, Securities=26.3, everything else is the same. Total reserves are now
23.9. RR=18.9, ER=5.
(c) Assets: Loans=155. Liabilities: Checkable Deposits=185. Everything else is the same.
RR=19.5, R=23.9, ER=4.4.
(d) Assets: Reserves=18.9. Liabilities: Checkable Deposits=180. Everything else is the same.
RR=R=18.9, so ER=0.
3. The federal funds rate rises (as First Bank pushes up the federal funds rate by demanding more
federal funds – i.e., borrowing more from other banks). Consequently, more banks borrow from
the Fed (i.e., using discount loans as an alternative to using federal funds). As a result, banks
hold fewer excess reserves.
4. [This answer refers to M1]. The money multiplier is one. The Fed can only affect the money
supply by changing the monetary base in this case.
5. Both M1 and M2 increase. The M1 multiplier rises because c falls. The M1 multiplier is
bigger than unity. The M2 multiplier rises because c falls and there is no change in the numerator
of the multiplier.
6. False. The Fed does not control all the elements of the monetary base. However, this does not
imply that the Fed cannot determine the size of the monetary base. In a world of perfect
information, the Fed can use the elements of the base that it can control to offset changes in the
elements that it cannot control. Recall that the Fed does have more control over the nonborrowed
monetary base than it does over the borrowed base (i.e., borrowed reserves).
