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. The money multiplier is generally greater than 1 because:

1. in a fractional-reserve banking system, each dollar bill is spent more than once (velocity is larger than 1), thereby increasing the money supply by more than $1.
2. in a fractional-reserve banking system, each dollar of reserves can support more than one dollar of deposits, thereby increasing the money supply by more than $1.
3. in a 100 percent reserve banking system, each dollar of reserves supports exactly one hundred dollars of deposits, thereby increasing the money supply by $100.
4. when a central bank increases bank reserves by $1, deposits are automatically increased by $1 as well, thereby increasing the money supply by $2.

The money multiplier is equal to 1 when:

1. reserves < deposits.
2. reserves > deposits.
3. reserves = deposits.

b. The initial money supply is $1,500, of which $700 is currency held by the public. The desired reserve-deposit ratio is 0.1. Calculate the increase in the money supply associated with increases in bank reserves of $10. What is the money multiplier in this economy? Assume that individuals do not change their currency holdings.

c. A general rule for calculating the money multiplier is:

1. 1/(deposit ratio-desired reserve).
2. 1/deposit ratio.
3. 1/desired reserve.
4. 1/(desired reserve-deposit ratio).

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 supply. In order to achieve its goal, the Fed would:

1. decrease the ratio of reserves to deposits.
2. increase reserve requirements.
3. increase the money supply.
4. decrease reserve requirements.