The Fed changes reserve requirements from 10 percent to 14 percent,thereby eliminating $750 million in excess reserves. The total change in deposits (with no drains)would be (rounded)

Question

Quizplus · Accepted Answer

The reserve requirements have increased by 4 percentage points (14% - 10% = 4%). This means that for every $100 deposited, banks need to hold $14 in reserve instead of $10. Hence, the excess reserves that banks had, $750 million, would now be required to be held as reserves.

Using the money multiplier formula:

Money Multiplier = 1/ Reserve Requirement

Before:
MM = 1/0.1 = 10

After:
MM = 1/0.14 = 7.14

The decrease in the money multiplier shows that the banks can now lend out less money for every $1 deposited.

Total Change in Deposits = (Decrease in Excess Reserves) x (Money Multiplier)

= (-750 million) x (7.14)

= -$5.355 billion

(Rounded to the nearest billion, the answer is $5.357 billion)

The Fed Changes Reserve Requirements from 10 Percent to 14