Question

1.      Beleaguered Bank has the balance sheet shown below. Assume that the bank’s desired reserve ratio is 10% of total deposits and that it ad just received this demand deposit.

Assets:	Liabilities:
Reserves                $50 000 Loans                    $50,000	Demand Dep.        $100,000

a.      (2) Does this bank carry any excess reserves? If yes, how much?

b.      (2) What is the maximum amount of loans this bank could have on its books?

c.       (2) Assume that Beleaguered Bank converts all of its excess reserves into loans. What is the maximum amount of deposits that is ultimately created in the entire banking system from the $100,000 of existing demand deposits? What is the money multiplier equal to?

d.      (2) Assume that the bank becomes more cautious and increases its desired reserve ratio to 15%. How would this affect the amount of deposits that can be created and how would the money multiplier change? Explain in words.

e.      (2) Now assume that a person deposits $3,000 in cash into a demand deposit at the Beleaguered Bank. By how much would the money supply or M1 increase as a result? Assume a reserve ratio of 10%.

Answer 1

Answer:

a.

This bank carries excess reserves worth $40,000.

It has deposits of $100,000 and reserve ratio is 10%. So, it's required reserves are $10,000 ($100,000*10%) and remaining $40,000 are excess reserves.

b.

Maximum loan this bank can give is Deposits-Required reserve=$100,000-$10,000=$90,000.

c.

If Beleaguered Bank converts all its excess reserves of $40,000 into loan, it can ultimately crete deposits of 10*$100,000=$1,000,000.

Money multiplier=1/Reserve ratio=1/10% or 1/0.10=10.

d.

If bank increase its desired reserve ratio to 15%, then it can create maximum deposits of $100,000/0.15=$666,666.6667.

Money multiplier will become 1/0.15=6.6667.

With increase in reserve ratio banks have to keep 15 % of deposits as Reserve and only 85% is given as loan. This loan amount is again deposited in the bank through various depositors and by circulating like this maximum deposits of $666,666.6667 can be created.

e.

If a person deposits $3000 in cash into a demand deposit, the money supply will be increased by $3000/10%=$30,000.