Question

Assume the US Consolidated Bank Balance Sheet has the following major balance sheet items (billions $) - Assets include Reserves at the Fed $8,000 and earning assets of (1) Treasury bonds and bills $12,000 (2) Loans $80,000 Total Assets equal $100,000. The only liability is demand deposits. The required reserve requirement rr=.08. The Fed Reserve balance sheet has Cash of $8,000 as an asset and Member Bank Deposits of $8,000 as a liability.

 (a) Set up the initial Consolidated Bank Balance Sheet and the Fed's initial balance sheet.

 (b) The Open Market Committee decides to purchase $4,000 in Treasury Securities from the Fed's member banks Show the short-run and then the long-run effects of this transaction on the Consolidated Bank Balance Sheet and on the Feds balance sheet. Assume that banks adjust their holding of loans but do not make any further changes in their holdings of Treasury Securities. Is this move expansionary or contractionary? Why

Answer 1

Solution to (a)

US CONSOLIDATED BANK Balance Sheet
Assets	$	Liabilities & Net worth	$
Reserve at Fed T-Bonds & Bills Loans	8,000 12,000 80,000	Demand Deposits	100,000
Total	100,000	Total	100,000

FED’s Balance Sheet
Assets	$	Liabilities & Net worth	$
Cash	8,000	Member’s Deposits	8,000
Total	8,000	Total	8,000

Solution to (b)

US CONSOLIDATED BANK Balance Sheet
Assets	$	Liabilities & Net worth	$
Reserve at Fed (8,000 + 4,000) T-Bonds & Bills (12,000 – 4,000) Loans	12,000 8,000 80,000	Demand Deposits	100,000
Total	100,000	Total	100,000

FED’s Balance Sheet
Assets	$	Liabilities & Net worth	$
Cash (8,000 + 4,000)	12,000	Member’s Deposits (8,000 + 4,000)	12,000
Total	12,000	Total	12,000

Note: When $4,000 T-securities is bought from FED’s member bank, the bond holdings of US Consolidated Bank fall by $4,000 and the bank’s reserves rise by $4,000. Similarly Fed’s member’s deposit will rise by $4,000 with a corresponding rise in cash holding also.

Balance Sheet Staus,If T-Securities holding is not changed further:

US CONSOLIDATED BANK Balance Sheet
Assets	$	Liabilities & Net worth	$
Reserve at Fed (12,000 - 4,000) T-Bonds & Bills Loans (80,000 + 4,000)	8,000 8,000 84,000	Demand Deposits	100,000
Total	100,000	Total	100,000

FED’s Balance Sheet
Assets	$	Liabilities & Net worth	$
Cash (12,000 - 4,000)	8,000	Member’s Deposits (12,000 - 4,000)	8,000
Total	12,000	Total	12,000

Notes: If US Consolidated Bank don’t want to make further change to it’s T-Securities, it has to loan out the extra $4,000 in reserve consequently its loan rise by$4,000.