Question

Assume the required reserve ratio at The First Bank of Idaho is 10%. The First Idaho Bank is a primary dealer, which means that it is a financial institution that is able to buy and sell securities directly to the U.S. Federal Reserve (Fed). Remember any bank in the U.S. can borrow from the Fed.

Provided below is the balance sheet for The First Bank of Idaho:

Type of Asset	Asset Amount	Type of Liability	Bank Capital
Reserves	$50,000	Checkable Deposits	$200,000
Loans	$120,000	Savings Deposits	$100,000
Securities	$150,000
		Bank Capital	$20,000

Use the information as well as the balance sheet for The First Bank of Idaho provided above to complete and answer the following:

What is the amount of excess reserves held by The First Bank of Idaho?

The Fed buys $50,000 of securities from The First Bank of Idaho and pays for those securities by increasing The First Bank of Idaho’s bank deposits at the Fed. Show the effect of this transaction on The First Bank of Idaho’s balance sheet.

When completing this part of your answer, remember that reserves equal bank deposits held at the Fed, plus vault cash.

What happens to excess reserves when the Fed buys securities from The First Bank of Idaho?

What happens to the amount of loans The First Bank of Idaho can create after the Fed buys securities? What will happen to the money supply if The First Bank of Idaho makes additional loans?

Go back to the original balance sheet. Suppose The First Bank of Idaho borrows $25,000 from the Fed. Show the effect of that transaction on The First Bank of Idaho’s balance sheet.

What happens to excess reserves at The First Bank of Idaho after the discount loan? What will happen to the money supply?

What happens to the amount of loans The First Bank of Idaho can create after the discount loan?

Go back to the original balance sheet. The Fed has a new tool that can pay interest on reserves held at the Fed. If the interest rate on reserves increases, will The First Bank of Idaho be more- or less-likely to hold excess reserves? What will happen to the amount of loans The First Bank of Idaho will make if the interest rate on reserves increases? What will happen to the money supply?

The Fed is currently using three tools: open market operations, interest rate on reserves, and forward guidance. Define each tool and explain how the Fed uses that tool to increase and decrease the money supply.

Answer 1