Assume that the following data describe the condition of the commercial banking system:

Total reserves: ....................................$85 billion

Transactions deposits: ....................$800 billion

Cash held by public: ........................$300 billion

Required reserve ratio: ................................0.10

1. How large is the money supply (M1)?

2. Are the banks fully utilizing their lending capacity? Now assume that the public transfers $20 billion in cash into transactions accounts.

3. What would happen to the money supply initially (before any lending takes place)?

4. How much would the total lending capacity of the banking system be after this portfolio switch?

5. How large would the money supply be if the banks fully utilized their lending capacity?

6. What three steps could the Fed take to offset this potential growth in M1?