Question

The government of Eastlandia uses measures of monetary aggregates similar to those used by the United States, and the central bank of Eastlandia imposes a required reserve ratio of \(10 \% .\) Given the following information, answer the questions below. Bank deposits at the central bank \(=\$ 200\) million Currency held by public \(=\$ 150\) million Currency in bank vaults \(=\$ 100\) million Checkable bank deposits \(=\$ 500\) million Traveler's checks \(=\$ 10\) million a. What is \(\mathrm{M} 1 ?\) b. What is the monetary base? c. Are the commercial banks holding excess reserves? d. Can the commercial banks increase checkable bank deposits? If yes, by how much can checkable bank deposits increase?

Short answer

Answer: The M1 money supply in Eastlandia is $660 million, and the monetary base is $450 million. Yes, commercial banks can increase checkable bank deposits by $2,500 million since they have $250 million in excess reserves.

Step-by-step solution

Calculate M1 Money Supply

M1 Money Supply = Currency held by public + Checkable bank deposits + Traveler's checks M1 = \(150 million + \)500 million + \(10 million = \)660 million So, M1 Money Supply is $660 million.

Calculate Monetary Base

Monetary Base = Currency held by public + Currency in bank vaults + Bank deposits at the central bank Monetary Base = \(150 million + \)100 million + \(200 million = \)450 million So, the Monetary base is $450 million.

Determine Excess Reserves

First, we need to calculate the required reserves. Required Reserves = Checkable bank deposits × Required reserve ratio = \(500 million × 10\% = \)50 million Actual Reserves = Currency in bank vaults + Bank deposits at the central bank = \(100 million + \)200 million = $300 million Now, let's find the excess reserves: Excess Reserves = Actual Reserves - Required Reserves = \(300 million - \)50 million = $250 million So, the commercial banks are holding $250 million in excess reserves.

Calculate the Increase in Checkable Bank Deposits

Since commercial banks have excess reserves, they can increase checkable bank deposits by extending loans. To find out how much checkable bank deposits can increase, you can use the money multiplier formula: Money Multiplier = 1 / Required Reserve Ratio = 1 / 10\% = 10 Increase in Checkable Bank Deposits = Excess Reserves × Money Multiplier = \(250 million × 10 = \)2,500 million So, commercial banks can increase checkable bank deposits by $2,500 million.