Below is the T-account for Country One Bank, the only bank in a small island nation. In addition to the dema?

Question

Below is the T-account for Country One Bank, the only bank in a small island nation. In addition to the demand deposits of $100,000, citizens hold $20,000 in coins and currency. Assume that demand deposits and currency are the only forms of money. Citizens also hold $40,000 of government bonds. These are not considered to be part of the money supply. The reserve ratio is 10%.

The central bank in this country undertakes open market operations and purchases $20,000 of bonds.

Use this information to answer the following questions.

Assets Liabilities

Reserves $10,000 Deposits $100,000

Loans $90,000

10.2. Assuming that the commercial bank does not change its reserve ratio and citizens continue to hold only $20,000 in coins and currency, what is the resulting change in the money supply after the money multiplier process is complete?

A. The money supply decreases by $200,000.

B. The money supply increases by $20,000.

C. The money supply decreases by $20,000.

D. The money supply increases by $200,000.

Answer 1

talk to a bank acountant

Answer 2

"A" is right one - since money multiplier = 1/10%=1/0.10=10 so after open-market operation money in circulation will be reduced by -20'000 and consequently money supply will be reduced by 20'000*10=$ -200'000. The only problem is - this economy doesn't have such money supply, so it seems like by purchasing bonds they will not be able to pay for it, so it will be added to liabilities and bonds will be added to assets (as M3 money).

More realistic picture for this economy would be:

Reserve requirement=10%

Cash in economy =$10'000+$20'000= $30'000

Currency drain=20% (20'000 hold citizens)

Money supply=30'000/(10%+20%)= 30'000/0.3=100'000

Money multiplier=1/0.3= 10/3=3.3(3)

So reduction of 20'000 would cause 20'000/0.3= $-66'666.6(6) fall in money supply.