C11E Document on Macroeconomics: Assignment

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ASSIGNMENT 08C11E MacroeconomicsDirections: Be sure to save an electronic copy of your answer beforesubmitting it to for grading. Unless otherwise stated, answer in completesentences, and be sure to use correct English, spelling and grammar.Sources must be cited in APA format. Your response should be four (4)double-spaced pages; refer to the "Assignment Format" page located on theCourse Home page for specific format requirements.Part A1.Why is the money multiplier in the United States smaller than theinverse of the required reserve ratio? Provide one (1) reason.Macroeconomic literature suggests money multiplier as the inverse reserverequirement ratio. For example, if the reserve ratio is 5% then the moneymultiplier will be 1/0.05 =20.Money multiplier plays an important role in banking system. Banks actuallyhold the fraction of reserve as the required reserve and lend out the excessreserve. Money multiplier is the key reason why the initial deposit leads to alarger increase in the money supply.In the real world the actual money multiplier is likely to be smaller thantheoretically calculated money multiplier. For example, for a 5% reserverequirement, then money multiplier is supposed to be 1/0.05=20 but in realworld the money multiplier is found to be less than 20. The calculation ofmoney multiplier is based on the assumption that what money banks lendsout, all will return. But it does not happen in reality. Money supply is likelyto be smaller than the formula suggests.
We usually assume that as the money supply changes, the cash holdings bythe public will not change. But in reality, it is different. In the depositcreation process, some reserves are withdrawn in the form of cash. Thiswould cause a smaller increase in demand deposit than what we expect. Wealso assume that banks lend out the whole excess reserve but it also doesnot happen in reality. They prefer to have some flexibility and lend smalleramount. As a result, demand deposit creation is getting smaller in eachround.[ CITATION Rob05 \l 16393 ]In US the money multiplier is estimated as between 2 and 3- this is muchsmaller than theoretical calculated value of money multiplier. This isbecause in reality people usually hold considerable portion of their loan ascash. So, the cash hold by the public are not available to the bank system tolend. As a consequence, the value of money multiplier comes down.[ CITATIONJam05 \l 16393 ]2.Explain why depositing cash into a checking account does not changethe money supply. Provide one (1) supporting fact.Depositing cash into checking account does not change the total moneysupply. It only changes the form of money from cash to demand deposits.It is very important because it increases bank’s ability to lend.[ CITATION Her15 \l 16393 ]For example, if we deposit $100 cash into checking account of Bank A.Banks keep the deposit of the cash into the vault- it results a $100 decrease
in the money supply. We know that currency held by the bank is notconsidered as the part of economy’s money supply. Due to the deposit of$100, the checking account component of money supply will be increasedby $100. Hence total money supply does not change. Moreover, Bank A willnot able to make any profit if it keeps all the money (that it receives) in thevault. It has to make loans to the public.[ CITATION Rob17 \l 16393 ]3.Explain why the money supply does not change when one individualwrites a check to another. Provide one (1) supporting fact.Money multiplier works in reverse manner also. If one individual writes acheck and give to other, money supply in the economy will not change. Forexample, if individual X writes a check of bank A and give it to Y, and if Ydeposits the check into his bank B, then total money supply will not change.The reason is very simple. The expansion of one bank’s reserve (Bank B)will offset by the contraction of the reserve of other bank (Bank A) resultingno change in money supply.[ CITATION Jam05 \l 16393 ]When an individual writes a check he other way instructs the to sell some ofhis money market certificates for cash. Money is transferred to the holdersof check but no new money is created it just changes the hand.[ CITATION FRA \l16393 ]
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