Question

Consider a bank whose total loans are equal to $800 million and required reserves are $40 million. The reserve requirement is 10%.

a) Fill in the bank’s balance sheet, assuming that it does not hold excess reserves.

Loans = $___ million;

Required reserves = $___ million

Deposits = $___ million;

Net worth = $___ million

Total assets = $___ million

b) The value of the money multiplier is .____ It depends_____on the reserve ratio (type in negatively or positively).

c) Suppose that the Fed injects $80 billion of new reserves into the banking system. Given the money multiplier computed in b), the total change in money supply in the whole banking system will be at most $____ billion

Answer 1

Bank has total loans of $800 million and required reserves of $40 million and the reserve requirement is 10%.

(a)

The loans are $800 million.

The required reserves are $40 million.

Deposits = Required reserves/Reserve requirement = $40 million/0.10 = $400 million

The deposits are $400 million.

Net worth = Loans + Required reserves - Deposits = $800 million + $40 million - $400 million = $440 million

The net worth is $440 million.

Total assets = Deposits + Net worth = $400 million + $440 million = $840 million

The total assets are $840 million.

(b)

Calculate the value of multiplier -

Multiplier = 1/Reserve requirement = 1/0.10 = 10

The value of the money multiplier is 10.

There exists an inverse relationship between reserve requirement and the money multiplier.

So,

It depends negatively on the reserve ratio.

(c)

New reserves in the banking system = $80 billion

Money multiplier = 10

Calculate the total change in the money supply -

Total change in money supply = New reserves * Money multiplier = $80 billion * 10 = $800 billion

Thus,

The total change in the money supply in the whole banking system will be at most $800 billion.