Posted by G-Unit on .
Consider a world in which there is no currency and depository institutions issue only checkable deposits and desire to hold no excess reserves. The required reserve ratio is 20 percent. The central bank sells $1 billion in government securities. What happens to the money supply? Give reasons to support your answer.
Some economists argue in favor of abolishing the government-sponsored deposit insurance.
Do you agree or disagree with this argument? Write a well-reasoned argument defending your stance.
If deposit insurance were abolished, explain how would this change the incentive structure facing depository institutions?
I) The money multiplier is 1/rr. In this proplem 1/.2=5. (For more info on the money multiplier, see www.wikipedia.org/wiki/Money_creation#Money_multiplier)
Since the central bank is selling securities, the public is buying using their demand deposits. I say the money supply goes down by $5B.
II) Take a shot, what do you think. (hint: strong arguments can be made for both keeping the insurance and eliminating the insurance. You may need to do a little research)