Question

Show the changes to the T-accounts for the Bank of Canada and for commercial banks when the Bank of Canada sells $30 million in treasury bills. If the public holds a fixed amount of currency (so that all new loans create an equal amount of cheque- able deposits in the banking system) and the minimum reserve ratio is 5%, by how much will cheque-able deposits in the commercial banks change? By how much will the money supply change? Show the final changes to the T-account for the commercial banks when the money supply changes by this amount.

Answer 1

The Bank of Canada sells $30 million in T_Bills to commercial banks. From Bank of Canada perspective it's assets in the form of T-Bill will decrease by $30 million and it's liability in the form of bank's monetary base and reserve will also decrease by the same amount.

Balance sheet of Bank of Canada

Assets	Liabilities
Treasury Bill -$30 million	Monetary Base -$30 million

From commercial bank's perspective, it's assets in the form of T-BIlls will increase but it;'s assets in the form of cash reserve will decrease reducing the money supply. There will be no immediate effect on the liabilities.

Balance sheet of Commercial Bank

Assets	Liabilities
Treasury Bill +$30 million	-
Cash Reserve -$30 million	-

Banks are olding $30 million fewer amounts in their cash reserve, commercial banks will lend out less cash. Requirememnt of minimum reserve ration is 5% would further reduce the amount available for loans and deposits.

5/100 *x = $30 million
=> (30*100) / 5 =$600 million

In order to suppost 5% reserve ratio, bank will have to reduce loans by $600 million.

The final T-accounts of commercial banks when money supply reduces

Assets	Liabilities
Treasury Bill +30 milion	Checkable Deposits -$600 million
Cash reserve -30 million
Loans -600 million