Scenario 16-1.The monetary policy of Namdian is determined by the Namdian Central Bank. The local currency is the dia. Namdian banks collectively hold 100 million dias of required reserves, 25 million dias of excess reserves, 250 million dias of Namdian Treasury Bonds, and their customers hold 1,000 million dias of deposits. Namdians prefer to use only demand deposits and so the money supply consists of demand deposits.
-Refer to Scenario 16-1. Suppose the Central Bank of Namdia loaned the banks of Namdia 5 million dias. Suppose also that both the reserve requirement and the percentage of deposits held as excess reserves stay the same. By how much would the money supply of Namdia change?
A)60 million dias
B)50 million dias
C)40 million dias
D)None of the above is correct.

Question

Quizplus · Accepted Answer

The money supply of Namdia would increase by the amount of the loan, which is 5 million dias, but since the reserve requirement and the percentage of excess reserves remain the same, the banks would only need to hold an additional 1.25 million dias of required reserves [(5 million x 25%) / 10%], leaving 3.75 million dias as excess reserves. Therefore, the maximum potential increase in the money supply is 3.75 times the initial loan of 5 million dias, or 18.75 million dias. However, since the banks already hold 25 million dias of excess reserves, the actual increase in the money supply would be smaller, equal to 18.75 million - 25 million = -6.25 million dias. Therefore, the money supply of Namdia would decrease by 6.25 million dias.

Note: It is important to remember that an expansionary monetary policy (such as a loan from the central bank) does not always lead to an increase in the money supply, as it depends on the behavior of banks and customers in response to the policy.