Chap 26

MONEY, BANKS, AND THE FEDERAL RESERVE 239
c. The banks’ reserve ratio is 2 percent.
The banks’ reserve ratio is the percent of deposits that is held as reserves. In Fredzone, deposits
are $500 billion and reserves are $10 billion, so the reserve ratio equals ($10 billion/$500
billion) × 100, which is 2 percent.
d. The currency drain is 16.67 percent.
The currency drain is the percent of the quantity of money that is held as currency by
households and firms. In Fredzone, deposits are $500 billion and currency is $100 billion, so the
quantity of money is $600 billion. The currency drain equals ($100 billion/$600 billion) × 100,
which is 16.67 percent.
11. a. The quantity of money increases to $333.67 billion.
The quantity of money increases by the change in the monetary base multiplied by the money
multiplier. The money multiplier is 7.33 (see 11c), so when the monetary base increases by $0.5
billion, the quantity of money increases by $3.67 billion. Initially, the quantity of money was
$330 billion, so the new quantity of money is $333.67 billion.
b. The change in the quantity of money is not equal to the change in the monetary base because of
the multiplier effect. The open market operation increases bank reserves and creates excess
reserves, which banks use to make new loans. New loans are used to make payments and some of
these loans are placed on deposit in banks. The increase in bank deposits increases banks’
reserves and increases desired reserves. But the banks now have excess reserves which they loan
out and the process repeats until excess reserves have been eliminated.
c. The money multiplier is the ratio of the quantity of money to the monetary base, which equals
$330 billion divided by $45 billion, which equals 7.33.
12. a. The quantity of money decreases to $594.55 billion.
The quantity of money increases by the change in the monetary base multiplied by the money
multiplier. The money multiplier is 5.45 (see 12c), so when the monetary base decreases by $1
billion, the quantity of money decreases by $5.45 billion. Initially, the quantity of money was
$600 billion, so the new quantity of money is $594.55 billion.
b. The change in the quantity of money is not equal to the change in the monetary base because of
the multiplier effect. The open market sale decreases bank reserves, so banks calls in loans to
restore their reserves to their desired level. As loans are repaid, the deposits decrease and the
quantity of money decreases. As deposits decrease, banks decrease their desired reserves further,
but desired reserves remain less than actual reserves. Banks continue to call in loans until actual
reserves equal desired reserves.
c. The money multiplier is the ratio of the quantity of money to the monetary base, which equals
$600 billion divided by $110 billion, which equals 5.45.