Assume that the reserve-deposit ratio is 0.2.The Bank of Canada carries out open-market operations,purchasing $1,000,000 worth of bonds from banks.This action increased the money supply by $2,600,000.What is the currency-deposit ratio?

Question

Quizplus · Accepted Answer

The reserve ratio is 0.2, which means that banks keep 20% of deposits as reserves and lend out the rest. When the Bank of Canada purchases $1,000,000 worth of bonds from banks, the banks receive $1,000,000 as deposits. Since they have to keep 20% of this as reserves, they can lend out the remaining 80%, which is $800,000. This $800,000 goes into circulation, increasing the money supply by $2,600,000 (as given in the question stem).

Using the formula for the money multiplier, we can find the currency-deposit ratio as follows:

Money multiplier = 1 / reserve ratio
2.6 = 1 / 0.2
Currency-deposit ratio = 1 - reserve ratio
Currency-deposit ratio = 1 - 0.2 = 0.8

Therefore, the currency-deposit ratio is 0.8, which means that for every dollar of deposits, there is $0.80 of currency in circulation.

Assume That the Reserve-Deposit Ratio Is 0