Suppose that the required reserve ratio is 12%, excess reserve is $300 billion, excess reserve ratio is 0.2 and currency in circulation is $1200 billion. (a) (6 marks) Calculate the money supply, and the money multiplier. (b) (6 marks) Suppose the Central Bank acts as a lender of last resort and lends $2000 billion to two failing commercial banks. However, instead of lending out the money and keeping the ratios constant, the commercial banks instead kept the extra borrowings from the Central Bank as excess reserve instead. Assume that currency and deposits remain the same (while excess reserve and excess reserve ratio change), calculate the new monetary base, money supply, and money multiplier.

To answer this question, we first need to understand some key concepts:

1. Required Reserve Ratio: This is the fraction of total deposits that a bank is required to keep as reserves.
2. Excess Reserves: These are reserves that a bank holds over and above the required level.
3. Money Multiplier: This is the amount of money the banking system generates with each dollar of reserves.

(a) To calculate the money supply, we first need to calculate the total reserves. Since the excess reserve is $300 billion and the required reserve ratio is 12%, we can calculate the total reserves as follows:

Total Reserves = Excess Reserves / Excess Reserve Ratio Total Reserves = $300 billion / 0.2 =$1500 billion

The money supply is then calculated as the sum of the total reserves and the currency in circulation:

Money Supply = Total Reserves + Currency in Circulation Money Supply = $1500 billion +$1200 billion = $2700 billion

The money multiplier is calculated as the inverse of the required reserve ratio:

Money Multiplier = 1 / Required Reserve Ratio Money Multiplier = 1 / 0.12 = 8.33

(b) If the Central Bank lends $2000 billion to the commercial banks and they keep it as excess reserves, the new excess reserves would be:

New Excess Reserves = Old Excess Reserves + Borrowings from Central Bank New Excess Reserves = $300 billion +$2000 billion = $2300 billion

The new total reserves would then be:

New Total Reserves = New Excess Reserves / New Excess Reserve Ratio New Total Reserves = $2300 billion / 0.2 =$11500 billion

The new money supply would be:

New Money Supply = New Total Reserves + Currency in Circulation New Money Supply = $11500 billion +$1200 billion = $12700 billion

The new money multiplier would be the same as before, 8.33, because the required reserve ratio has not changed.