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Assume that Jill deposits $20,000 in cash into her checking account at Welcome National Bank and the central bank has set a required reserve ratio of 10%.
A. Explain the immediate effect of her deposit on the M1 measure of the money supply.
B.If Welcome National Bank holds an additional 10% of her deposit in reserves, calculate the following:
-the maximum amount the bank will loan out
-the maximum increase in the money supply as a result of this transaction

Respuesta :

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M1 is reserves which can easily be converted to cash. Such amounts should always be reserved as liquid in the banks.

A. The deposit of $20,000 increases M1 by 10% of the amount deposited. That is,
M1 increase = 0.1*20,000 = $2,000.

B. Part 1
Amount to be loaned out = Deposit - (Total reserve*Deposit) = 20,000 - [(2*0.1)*20,000] = 20,000 - 4,000 = $16,000

B. Part 2
Increase in money supply = 20% of deposit - 10% of deposits = Deposit (20%-10%) = 20,000 (0.2 -0.1) = 20,000(0.1) = $2,000

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