Economics - Monetary Base?

Question

This question (which comes in 2 parts) is one that i've been having trouble with.

(a) Given the following information calculate the affect of 1% increase in Monetary Base on M: Bank deposits are $100 million of which $7 million are kept to meet the daily liquidity requirements. In addition to the deposits public prefers to hold $25 million in cash.

I think this is referring to the formula

M = m * MB

or

Money Supply = money multiplier * monetary base

I think it says that a 1 percent increase in Monetary Base = what change in Money Supply. If that is the case then the money supply should increase but I don't know by what amount or how to use the other parts of the question to find my answer.

(b) If people’s desire to hold cash drops to zero what will be the impact of 1% increase in Monetary Base on M?

This part I don't have a clue how to get the answer.

Please help me with this question, I am utterly confused how to work this out.

Thanks

Answer 1

A)

You have money-supply

$7m - bank reserves (reserve requirement)

$100m - bank liabilities

$25m - currency drain

Monetary base is all that kept in cash

MB=$7m+$25m = $32m

MS=MB+Deposits=$32m + $100m=$132m

MM=132/32=4.125

MS=MM*MB

ΔMB=+1%

ΔMS=MM*ΔMB

ΔMS=4.125 * 1.01 = +4.125%

Or using multiplier:

ΔMS= MS(Old) * 1.04125

B)

Currency drains falls to zero.

Since deposits are $100m and reserves are $7m then reserve requirement is 7/100=0.07 or 7%

MM=1/0.07=14.28571429

♦Money-supply with currency drain:

MS(very old)=$32m + $100m=$132'000'000

♦Money-supply without currency drain:

MS(old)=MB*MM= $32m*14.28571429 = $457'142'857.1

ΔMB=+1%= 32*0.01=0.32

MB(new)=$32*1.01 = $32.32m

♦Money-supply without currency drain and after 1% MB increase:

MS(new)= $32.32m * 14.28571429 = $461'714'285.7