Question

Show the changes to the balance sheets for commercial banks when the Federal Reserve buys $50 million in US Treasury Bills. If the public holds a fixed amount of currency ( so that all loans create an equal amount of deposits in the banking system), the minimum reserve requirement is 5%, by

how much will checkable bank deposits in commercial banks change?

b) Now suppose that the Fed raises the discount rate significantly.How would you expect this to affect the balance sheet of local banks? Is this likely to decrease or increase M1?

Answer 1

When Ded buys $50 million in US Treasury Bills, then the commercial recieves initial $50 million in their deposits account. the bank kept the minimum resrves in thier account and lend all the excess reserves money .

a)

reserve requirement= 5% or0.05

minimum reserves = deposits * RRR

minimum reserves = 50 * 0.05 = 2.5 million dollar

excess reserves = Reserves - minimum reserves

excess reserves = 50 -2.5 = 47.5 million dollar..

so the bank can give 47.5 million dollar in the loans.

the checkable deposits account in commercial bank change by = deposit amount * money multiplier

= 50* 1/ 0.05

= 50*20 = 1000 millions dollars.

Assets	Liabilites
Reserves = 2.5 million	Deposits = 50 million
loans = 47.5 million.

b) WHen Fed raises the discount rate, the bank has pay more interest when the borrow from other banks . therefore the money supply will decrease . thus this process is known as contractionary monetary policy. SO m1 will decrease after the Fed raises the discount rate.