Question

Initially Alexander Bank kept 10% of desired reserve ratio and no excess reserves. In March, worrying about the liquidity shortage caused by pandemic panic, Alexander Bank sold $50 million of bond holdings to the Bank of Canada in the open market.
a) Use T-account to show the change of Alexander Bank’s balance sheet reflecting this bond transaction.
b) Use T-account to show the change of the Bank of Canada’s balance sheet reflecting this bond transaction.
c) After a month of lockdown, now most businesses are re-opened. To maximize profit, Alexander Bank starts making loans to its customers. What is the maximum amount of loans it can make? Use T-account to show the change for its balance sheet reflecting this lending alone.
d) Assume all commercial banks have desired reserve ratio 10% and no excess reserves, and the currency-deposit ratio is 0. After the multiple deposit creation process is completed, what is the net change for the balance sheet of the whole commercial banking system? Show the T-account.

Answer 1

Answer:

a)

Balance Sheet of Alexander Bank

Assets	Amount ($)	Liabilities	Amount ($)
Reserves	+$50 million
Bonds	-$50 million

Bonds are sold so amount of bond will decrease by $50 million and reserves of $50 million are created by selling bonds

b)

Balance Sheet of Bank of Canada

Assets	Amount ($)	Liabilities	Amount ($)
Bonds	+$50 million	Reserves	+50 million

c)

Balance Sheet of Alexander Bank

Assets	Amount ($)	Liabilities	Amount ($)
Reserves	-$50 million
Loans	+$50 million

d)

Balance Sheet of All Commercial Banks

Assets	Amount ($)	Liabilities	Amount ($)
Reserves	+$50 million	Deposit	+500 million
Loan	+$450 million

Loan of $50 million granted by the Alexander Bank will create a deposit of $50 million and out of the deposit of $50 million loan of $45 million ($50 million-10%*$50million) will again be granted and reserve of $ 5 million will be created This will again be deposited into the bank and circulation will continue till a total money supply of Multiplier times Initial deposit is created. Here Multiplier=1/Reserve requirement=1/10%=10. So total money creation will be $50 million*10=$500 million, shown as deposit in the Liability side of composite Balance sheet of all commercial banks. Also reserve of $50 million and loans of $450 million will appear on the assets side of the balance sheet.