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Leakage Adjusted Money Multiplier

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Suppose the ratio of deposits that banks hold in the form of reserves is 7 percent. Suppose further that people want to hold 8 percent of their deposits in the form of cash. Then, if the fed wants the money supply to be $6,228 billion, what is the necessary level of high powered money?

Assume an economy in which the reserve ratio is 15 percent, people hold 10% of their deposits in the form of cash, and there are no other leakages. (a) Compute the value of the money multiplier. (b) If the current level of high-powered money is $1,500 billion, what is the money supply in this economy? (c) How much does the money supply change if the fed buys $30 billion of U.S. government treasury bills from a government bond dealer? How about if banks borrowings of reserves from the fed decline by $6 billion? (d) if the fed set a target money supply of $6,424 billion what would it have to do to achieve that target?

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Solution Summary

The leakage adjusted money multiplier is explained with calculations in 372 words.

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The first thing you need for this is to define the leakage adjusted money multiplier.

Assume the required reserve ratio is r, the banks' propensity to hold excess reserve, as a fraction of total reserves is e and borrowers' tendency to hold cash, as a fraction of cash is c. Then,

the leakage-adjusted money multiplier = 1/(r+e+c)

In this case banks do not have a tendency to hold excess cash, and hence e = 0. The required reserve ratio in the first case is 7%, and the borrowers' tendency to hold ...

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