Question

Bank Three currently has $950 million in transaction deposits on its balance sheet. The Federal Reserve has currently set the reserve requirement at 6 percent of transaction deposits.

a. If the Federal Reserve decreases the reserve requirement to 4 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.

panel A initial balance sheets: federal reserve bank:

Assets:______ Millions Liabilities _____________ millions

bank three:

Assets:______ Millions Liabilities _____________ millions

Assets:______ Millions

panel B: balance sheet after all changes: federal reserve bank:

Assets:______ Millions Liabilities _____________ millions

bank three

Assets:______ Millions Liabilities _____________ millions

Assets:______ Millions

b. Redo part (a) using a 10 percent reserve requirement.

panel A initial balance sheets: federal reserve bank:

Assets:______ Millions Liabilities _____________ millions

bank three:

Assets:______ Millions Liabilities _____________ millions

Assets:______ Millions

panel B: balance sheet after all changes: federal reserve bank:

Assets:______ Millions Liabilities _____________ millions

bank three

Assets:______ Millions Liabilities _____________ millions

Assets:______ Millions

Answer 1

Solution

a.

Panel A: Initial balance sheets (in millions)

Federal Reserve Bank
Assets		Liabilities
Securities	57	Reserve Accounts	57

BSW Bank
Assets		Liabilities
Loans (950-57)	893	Transaction deposits	950
Reserve deposits at Fed	57

Panel B: Balance sheet after all changes

Federal Reserve Bank
Assets		Liabilities
Securities	57	Reserve Accounts	57

BSW Bank
Assets		Liabilities
Loans (1425-57)	1368	Transaction deposits (57/0.04)	1425
Reserve deposits at Fed	57

New initial required reserves = 0.04 × $950 million = $38 million
Change in bank deposits = (1/0.04) × ($57 million − $38 million) = $475 million

b.

Panel A: Initial balance sheets (in millions)

Federal Reserve Bank
Assets		Liabilities
Securities	57	Reserve Accounts	57

BSW Bank
Assets		Liabilities
Loans 950-57)	893	Transaction deposits	950
Reserve deposits at Fed	57

Panel B: Balance sheet after all changes

Federal Reserve Bank
Assets		Liabilities
Securities	57	Reserve Accounts	57

BSW Bank
Assets		Liabilities
Loans (570-57)	513	Transaction deposits (57/0.10)	570
Reserve deposits at Fed	57