Demand deposit multiplier and reserve ratio
When banks have no excess reserves, the reserve ratio is 0.1 and the demand deposit multiplier is 10. This means that the banks required reserve is 10% of their deposits.
However, what is the multiplier when including both the excess and required reserves?
For part (b) you would use the multiplier that you have obtained in part (a) and also keep in mind the the 5% in excess reserves the banking system has.
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Complete the following problem:
Sometimes banks wish to hold reserves in excess of the legal minimum. Suppose
that banks are initially fully loaned up and the required reserve ratio is 0.1. Then the
Fed makes an open market purchase of $100,000 in government bonds, and each
bank decides to hold excess reserves equal to 5 percent of its deposits.
a) Derive the demand deposit multiplier in this case. Is it larger or smaller than
when banks hold no excess reserves?
b) What is the ultimate change in demand deposits in the entire banking system?