Question

Bank Three currently has $450 million in transaction deposits on its balance sheet. The Federal Reserve has currently set the reserve requirement at 8 percent of transaction deposits.

a. If the Federal Reserve decreases the reserve requirement to 6 percent, show the balance sheet of Bank Three and the Federal Reserve System just before and after the full effect of the reserve requirement change. Assume Bank Three withdraws all excess reserves and gives out loans and that borrowers eventually return all of these funds to Bank Three in the form of transaction deposits.
b. Redo part (a) using a 10 percent reserve requirement.

Answer 1

a) Reserves = $450 million x 8% = $36 million

balance sheets before effect of reserve requirement change -

Federal Reserve System (in $ million)

Assets	Amount	Liabilities	Amount
Treasury Securities	36	Reserves	36

Bank Three (in $ million)

Assets	Amount	Liabilities	Amount
Reserves	36	Deposits	450
Loans (balancing figure)	414
Total	450	Total	450

Above are the initial balance sheets.

New reserve requirement = 6%

Now, deposits are increased by the loans that borrowers return which are nothing but the excess reserves.

So, New deposits = Reserves / Reserve requirement = $36 million / 6% = $600 million

New balance sheets after effect of reserve requirement change -

Federal Reserve System (in $ million)

Assets	Amount	Liabilities	Amount
Treasury Securities	36	Reserves	36

Bank Three (in $ million)

Assets	Amount	Liabilities	Amount
Reserves	36	Deposits	600
Loans (balancing figure)	564
Total	600	Total	600

b) Reserves = 10% x $450 million = $45 million

balance sheets before effect of reserve requirement change -

Federal Reserve System (in $ million)

Assets	Amount	Liabilities	Amount
Treasury Securities	45	Reserves	45

Bank Three (in $ million)

Assets	Amount	Liabilities	Amount
Reserves	45	Deposits	450
Loans (balancing figure)	405
Total	450	Total	450

balance sheets after effect of reserve requirement change -

Federal Reserve System (in $ million)

Assets	Amount	Liabilities	Amount
Treasury Securities	45	Reserves	45

Bank Three (in $ million)

Assets	Amount	Liabilities	Amount
Reserves	45	Deposits (45 / 6%)	750
Loans (balancing figure)	705
Total	450	Total	450