I n t h I s c h a p t e r y o u w I l L

A
SSETS
L
IABILITIES
Reserves
$100,000
Deposits
$500,000
Loans
400,000
a.
If the Fed requires banks to hold 5 percent of
deposits as reserves, how much in excess reserves
does First National now hold?
b.
Assume that all other banks hold only the required
amount of reserves. If First National decides to
reduce its reserves to only the required amount,
by how much would the economy’s money
supply increase?
10. Suppose that the reserve requirement for checking
deposits is 10 percent and that banks do not hold any
excess reserves.
a.
If the Fed sells $1 million of government bonds,
what is the effect on the economy’s reserves and
money supply?
b.
Now suppose the Fed lowers the reserve
requirement to 5 percent, but banks choose to hold
another 5 percent of deposits as excess reserves.
Why might banks do so? What is the overall change
in the money multiplier and the money supply as a
result of these actions?
11. Assume that the banking system has total reserves of
$100 billion. Assume also that required reserves are 10
percent of checking deposits, and that banks hold no
excess reserves and households hold no currency.
a.
What is the money multiplier? What is the money
supply?
b.
If the Fed now raises required reserves to 20 percent
of deposits, what is the change in reserves and the
change in the money supply?
12. (This problem is challenging.) The economy of
Elmendyn contains 2,000 $1 bills.
a.
If people hold all money as currency, what is the
quantity of money?
b.
If people hold all money as demand deposits and
banks maintain 100 percent reserves, what is the
quantity of money?
c.
If people hold equal amounts of currency and
demand deposits and banks maintain 100 percent
reserves, what is the quantity of money?
d.
If people hold all money as demand deposits and
banks maintain a reserve ratio of 10 percent, what is
the quantity of money?
e.
If people hold equal amounts of currency and
demand deposits and banks maintain a reserve
ratio of 10 percent, what is the quantity of money?

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6 2 7
I N T H I S C H A P T E R
Y O U W I L L . . .
C o n s i d e r t h e v a r i o u s
c o s t s t h a t i n f l a t i o n
i m p o s e s o n s o c i e t y
S e e w h y s o m e
c o u n t r i e s p r i n t s o
m u c h m o n e y t h a t
t h e y e x p e r i e n c e
h y p e r i n f l a t i o n
S e e w h y i n f l a t i o n
r e s u l t s f r o m r a p i d
g r o w t h i n t h e m o n e y
s u p p l y
L e a r n t h e m e a n i n g
o f t h e c l a s s i c a l
d i c h o t o m y a n d
m o n e t a r y n e u t r a l i t y
E x a m i n e h o w t h e
n o m i n a l i n t e r e s t
r a t e r e s p o n d s t o t h e
i n f l a t i o n r a t e
Although today you need a dollar or two to buy yourself an ice-cream cone, life
was very different 60 years ago. In one Trenton, New Jersey, candy store (run, inci-
dentally, by this author’s grandmother in the 1930s), ice-cream cones came in two
sizes. A cone with a small scoop of ice cream cost three cents. Hungry customers
could buy a large scoop for a nickel.
You are probably not surprised at the increase in the price of ice cream. In our
economy, most prices tend to rise over time. This increase in the overall level of
prices is called