Concept explainers
Sub-part
A
The amount that the bank should lend, assuming that it holds no
Sub-part
A
Explanation of Solution
a. If Bank A wishes to hold no excess reserves form the deposit of $1,000, then the deposits would go up by $1,000 in liabilities. In the assets, the required reserves increase by $100 (10%
Bank A's | |||
Assets | Liabilities | ||
Reserves | $100 | Deposits | $1,000 |
Loans | $900 |
Introduction:
The Federal Reserve and banking system are responsible for the creation of money in the economy. The first step of this money creation process starts when the Federal Reserve injects money in the economy by buying bonds. This money is stored in a bank. Then, the bank would keep the required reserves with themselves, and lent the remaining excess reserves. These excess reserves will then be stored with some other bank and the other bank would also keep the required reserve and make a loan for the remaining amount. These excess reserves keep flowing in the economy, thus, creating money at every stage. A bank’s balance sheet has the deposit account and capital account on the liabilities side, and cash reserves, required reserves, loans, and securities are on the asset side of the bank’s balance sheet that are affected by the money creation process.
Sub-Part
B
The changes in the balance sheet of bank B, when maximum amount is lent..
Sub-Part
B
Explanation of Solution
The Bank B receives a deposit of $900 which it plans to lend keeping the required reserve. Thus, it will have similar effects as in part A. Bank B’s deposits increase by $900, and its reserves and loans increase by $90 (10% required reserve of $900) and $810 respectively.
Bank B's balance sheet | |||
Assets | Liabilities | ||
Reserves | $90 | Deposits | $900 |
Loans | $810 |
Introduction:
The Federal Reserve and banking system are responsible for the creation of money in the economy. The first step of this money creation process starts when the Federal Reserve injects money in the economy by buying bonds. This money is stored in a bank. Then, the bank would keep the required reserves with themselves, and lent the remaining excess reserves. These excess reserves will then be stored with some other bank and the other bank would also keep the required reserve and make a loan for the remaining amount. These excess reserves keep flowing in the economy, thus, creating money at every stage. A bank’s balance sheet has the deposit account and capital account on the liabilities side, and cash reserves, required reserves, loans, and securities are on the asset side of the bank’s balance sheet that are affected by the money creation process.
Sub-Part
C
The same process for banks C, D and E.
Sub-Part
C
Explanation of Solution
b. Similar, effects will take place in Banks C, D, and E. Each of their deposit will increase, and, holding 10% of reserves, their loans will increase too.
Bank C's balance sheet | |||
Assets | Liabilities | ||
Reserves | $81 | Deposits | $810 |
Loans | $729 |
Bank D's balance sheet | |||
Assets | Liabilities | ||
Reserves | $72.90 | Deposits | $729.00 |
Loans | $656.10 |
Bank E's balance sheet | |||
Assets | Liabilities | ||
Reserves | $65.61 | Deposits | $656.10 |
Loans | $590.49 |
Introduction:
The Federal Reserve and banking system are responsible for the creation of money in the economy. The first step of this money creation process starts when the Federal Reserve injects money in the economy by buying bonds. This money is stored in a bank. Then, the bank would keep the required reserves with themselves, and lent the remaining excess reserves. These excess reserves will then be stored with some other bank and the other bank would also keep the required reserve and make a loan for the remaining amount. These excess reserves keep flowing in the economy, thus, creating money at every stage. A bank’s balance sheet has the deposit account and capital account on the liabilities side, and cash reserves, required reserves, loans, and securities are on the asset side of the bank’s balance sheet that are affected by the money creation process.
Sub-Part
D
The total change in the money supply as a consequence of $1000 initial deposit.
Sub-Part
D
Explanation of Solution
The change in the money supply takes place when the excess reserves are lent out by the first bank. The formula to calculate the change in money supply is change in fresh reserves times the reciprocal of the reserve ratio. Thus,
Introduction:
The Federal Reserve and banking system are responsible for the creation of money in the economy. The first step of this money creation process starts when the Federal Reserve injects money in the economy by buying bonds. This money is stored in a bank. Then, the bank would keep the required reserves with themselves, and lent the remaining excess reserves. These excess reserves will then be stored with some other bank and the other bank would also keep the required reserve and make a loan for the remaining amount. These excess reserves keep flowing in the economy, thus, creating money at every stage. A bank’s balance sheet has the deposit account and capital account on the liabilities side, and cash reserves, required reserves, loans, and securities are on the asset side of the bank’s balance sheet that are affected by the money creation process.
Sub-Part
E
The effect on the total change in the money supply with holding the level of excess reserves.
Sub-Part
E
Explanation of Solution
If each of the banks plans to hold 5% excess reserves, then the money supply will reduce by 5%. Thus, the reserve ratio increases from 10% to 15%. With this effect, the change in money supply will be as follows:
Introduction:
The Federal Reserve and banking system are responsible for the creation of money in the economy. The first step of this money creation process starts when the Federal Reserve injects money in the economy by buying bonds. This money is stored in a bank. Then, the bank would keep the required reserves with themselves, and lent the remaining excess reserves. These excess reserves will then be stored with some other bank and the other bank would also keep the required reserve and make a loan for the remaining amount. These excess reserves keep flowing in the economy, thus, creating money at every stage. A bank’s balance sheet has the deposit account and capital account on the liabilities side, and cash reserves, required reserves, loans, and securities are on the asset side of the bank’s balance sheet that are affected by the money creation process.
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