Wednesday, March 11, 2015

Monetary Policy (Reserve Requirements) FRQ's & MC

Monetary Policy (Reserve Requirements) FRQ's & MC

So I have started to try and create a google site for all of my information. Don't laugh.

I'm posting a link to the google site so you can download the FRQ's & MC questions for the Reserve Requirements (T-accounts) for the Monetary Policy section of the course.

Here is the link,, problems? e-mail me

mjmfoodie - video - Reserve Requirements (Money Creation)

Excellent summary of monetary policy and how banks create money.
Take the time to read it as it touches upon most of what you will need to do well on the AP Exam.

Let's go through a few and see if we can understand what the college board is testing.

Money Multiplier (Creation) Money Supply Increase

1995 AP Macro Exam
Answer (D) $500
(money already in excess reserves)

So, The Reserve Requirement is 20% (they must keep on reserve 20% of the checkable deposited amount), there is $100 dollars worth of excess reserves, how much money creation can happen within the money supply. (Think: money multiplier)

If the RR is 20% or .2 and the multiplier is (1/RRR) = 1/.2 = 5 ,, so the multiplier is 5

If there is $100 in excess reserves we simply take the 100 x 5 = $500 increase in the Money Supply.

  1. Don't get confused,, you need the 20% RR to figure out the multiple (1/.2 = 5)
  2. Not to subtract the 20% from the $100. 
  3. As the $100 dollars is already in excess reserves
  4. If the $100 dollars had been a checking deposit (deposited by someone) then you would have subtracted the $20 from the $100 and multiplied $80 x 5 and the money supply would have increased by $400.
  5. AS the amount was already in excess reserves, the whole amount in excess reserves is multiplied by the 5.
2008 AP Macro Exam
Answer (C) $900
(money deposited in checking account)

So, the RR is 10%,,  and the multiplier is (1/RRR) =  1/.1 = 10 is the multiplier.

There is a checkable deposit of $100 - (the RRR = 10% of $100 = $10 dollars) = $100 - $10 = $90

So, now we have $90 in excess reserves, & the money supply is expanded by the multiplier x the change in the excess reserves.

$90 x 10 = $900
  1. You needed the RR 10% to have the multiple
  2. Since it was a deposit you have to subtract out the RR
  3. The difference is it goes into excess reserves and can be re-loaned out again.
  4. This is the essence of fractional reserve banking.
  5. What if the RR had been 20%
  6. If the RR was 20% the multiple would be 5 not 10 like above.
  7. This makes sense as the higher the RR the less money creation (loans) can take place.
  8. 20% would be subtracted from the $100 checkable deposit to leave $80
  9. The $80 dollars would be placed in excess reserves to be re-loaned.
  10. Then the MS would increase by 5 x 80 = $400