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ASA_Woman
04-28-2002, 12:03 AM
I don't understand this macro question from the CSM manual:

An economy has a fractional reserve banking system. The reserve requirement (r) in this economy is less than one-half. People in this economy hold some money in the form of cash in their pockets and some as demand deposits at banks. Banks hold no excess reserves. Determine the final impact of an increase of B in the monetary base.

Answer: The level of required reserves will increase, and the money supply will increase by more than B but less than B/r.

The explanation goes like this: Since required reserves are related to the money supply, an increase in the money supply will increase in the amount of required reserves.

Change in Money Supply = (1-r)B/r B&lt;Change in Money Supply&lt;B/r

Now I have in the notes that the expanded money supply function is

M = (1/k) [Q-(1-k)C - RF+B(r,rd)] where

k = reserve requirement ratio
Q = securities portfolio
C = currency
RF = free reserves
B = borrowings by banks from the central bank
r = market interest rate
rd = discount rate

My question is this:
So is B as stated in this question actually equivalent to C (currency) and not B (borrowings by banks from the central bank)??

aces219
04-28-2002, 02:09 AM
B in the question looks like it could be C in the formula, but "currency" is a vague term. Does that mean monetary base or money held by consumers? It is definitely not the same as B in the formula.

My suggestion with macro is to think about it rather than trying to plug into formulas (with the exception of national accounting questions). You can reason this problem out without knowing the formula at all, and there is enough to memorize on this exam.

Macroman
04-28-2002, 04:06 PM
Currency is the monetary base. In this question B is the change in the monetary base.

I second the notion that you don't need the formula you quote for course #2. What you need are the multiplier formulas,
ie dM = dC*((1-r)/r)

where M is the total money supply, C is the monetary base, and dM and dC are the changes to the respective basic variables. Multipliers are a very important concept for passing this exam.

ASA_Woman
04-28-2002, 04:56 PM
Ok, I see that I am making this question more complicated than it has to be. Thanks.