The required reserve ratio is 0.2, the level of deposits is $1,000, the level of currency held by the public is $500, the level of excess reserves is $300, the level of money market funds is $500 and the level of time deposits is $1,500. If the Fed lowers the monetary base by $100, what is the change in M1?

Question

Quizplus · Accepted Answer

M1 includes currency held by the public and demand deposits. Lowering the monetary base directly reduces the amount of currency in circulation and the reserves banks hold, affecting their ability to create loans. With a required reserve ratio of 0.2, every dollar of reserves supports $5 of deposits. Reducing the monetary base by $100 reduces potential deposits by $500 ($100 * 5). However, since there are $300 in excess reserves, the actual reduction in deposits is only $200 ($500 - $300 in excess reserves). The total change in M1 is the sum of the change in currency ($100) and the change in deposits ($200), totaling a $300 reduction.

The Required Reserve Ratio Is 0