When a central bank increases bank reserves by $1, the money supply rises by more than $1. The amount of extra money created when the central bank increases bank reserves by $1 is called the money multiplier.
a. Explain why the money multiplier is generally greater than 1. In what special case would it equal 1?
b. The initial money supply is $1,000, of which $500 is currency held by the public. The desired reserve-deposit ratio is 0.2. Find the increase in money supply associated with increases in bank reserves of $1, $5, and $10. What is the money multiplier in this economy?
c. Find a general rule for calculating the money multiplier.
d. Suppose the Fed wanted to reduce the money multiplier, perhaps because it believes that change would give it more precise control over the money sup¬ply. What action could the Fed take to achieve its goal?