Question

Assume that the following balance sheet portrays the state of the banking system. The banks currently have no excess reserves.

Assets		Liabilities and Net Worth
(Billions of Dollars)
Total reserves	5	Checkable deposits	50
Loans	25
Securities	20
Total	50	Total	50

What is the required reserve ratio?

10%

40%

5%

25%

Suppose that the Federal Reserve (the "Fed") sells $4 million of bonds to a bond dealer, who pays the Fed by writing a check against the funds in her checking account. What is the initial impact of this transaction?

The banking system's holdings of securities fall by $4 million, and the banking system's total reserves rise by $4 million.

Checkable deposits fall by $4 million, and the banking system's holdings of securities fall by $4 million.

Checkable deposits fall by $4 million, and the banking system's total reserves fall by $4 million.

The banking system's holdings of securities rise by $4 million, and the banking system's total reserves fall by $4 million.

As a result of the Fed's sale of $4 million of securities, checkable deposits in the banking system can potentially   by as much as   .

Answer 1

(A). The following formula is used to calculate required reserve ratio:-

Required reserve ratio = Reserve / Checkable Deposits * 100

                                             = 5 / 50 * 100

                                             = 0.1 * 100

                                             = 10%

Thus, required reserve ratio is 10%.

(B). Answer is Option (C) Checkable deposits fall by $4 million, and the banking system's total reserves fall by $4 million.

A deposit of $4 million will decrease the bank's checkable deposit by $4 million and decrease total reserves by $4 million.

(C). Checkable Deposits can decrease by $40 million

The total increase in deposits can decrease in banking system = Initial Increase in Checkable Deposits / Required reserve ratio

= $4 Million / 0.10

= $40 Million