Question

Nassim Bank is a commercial bank in Jaya with the following balance sheet (T-account).


Assets Liabilities

Reserves $80,000

Demand Deposits $400,000

Government Bonds $920,000

Owners’ Equity $600,000

(a) Calculate the required reserve ratio if Nassim Bank holds no excess reserves. Show your work.


(b) The central bank of Jaya buys $20,000

of government bonds from Nassim Bank. What is the dollar value of the change in the monetary base? Explain using numbers.


(c) Based on your answer to part (a), calculate the maximum change in the money supply as a result of the central bank bond purchase after all adjustments take place in the banking system. Show your work.


(d) Given the change in the money supply in part (c), calculate the velocity of money if nominal gross domestic product changes by $500,000
. Show your work.


(e) Assume the economy of Jaya is initially at full employment. Based solely on the change in the money supply in part (c), will the price level increase, decrease, or stay the same in the short run? Explain

Answer 1

The reserve ratio at no excess reserves by Nassims bank is 0.2 or 2 percent using details from the T account.

A. The formula for reserve ratio

$\frac{reserves}{demand deposit}$

= 80000/400000

= 0.2

b. If the Fed of Java buys 20000 dollars from the bank Nassim. they would have to pay with the reserves.

The reserves of Nassim would then rise by $20000. The monetary base rises by $20000 too. Since it is inclusive of reserve, the change in monetary base is $20000.

c. Change in reserve = +20000

monetary multiplier= 1/reserve ratio

1/0.2 = 5

5* $20000

= $100000

The money supply is going to rise by $20000 if the fed buys $20000 worth of reserves from the bank.

d. The velocity of money

V = PT/M

= 500000/100000

= $5

e. If the economy is at full employment, the change in the money supply would cause price level to increase.

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