Question

Suppose you deposit $4,000 in currency into your checking account at Bank of America. Assume that Bank of America has no excess reserves at the time you make your deposit and that the required reserve ratio is 10 percent. 1) Use a T-account to show the initial effect of this transaction on bank of America's balance sheet. 2) Suppose that Bank of America makes the maximum loan they can from the funds you deposited. Use a T-account to show the initial effect on Bank of America's balance sheet from granting the loan. Also include in this T-account the transaction from question (1). 3) What is the maximum increase in checking account deposits of the whole banking system that can result from your $4,000 deposit? What is the maximum increase in the money supply? Are they equal? Why?

I need full answers AND explanation ASAP

Answer 1

(1)

Deposit of $4,000 has been made into checking account of Bank of America.

Following is the required T-Account -

Assets		Liabilities
Reserves	$4,000	Checking Deposits	$4,000

(2)

New deposit = $4,000

Required reserve ratio = 10% or 0.10

Required reserve created = $4,000 * 0.10 = $400

Excess reserves created = $4,000 - $400 = $3,600

Bank can lend an amount equal to excess reserves.

So, Bank of America will make a loan of $3,600.

When bank make loan, it does not give cash but open a checking account in name of borrower.

Following is the required T-Account -

Assets		Liabilities
Reserves	$4,000	Checking deposits	$7,600
Loans	$3,600

(3)

Money multiplier = 1/required reserve ratio = 1/0.10 = 10

Calculate maximum increase in checking account deposits -

Maximum increase = Initial deposit * money multiplier = $4,000 * 10 = $40,000

The maximum increase in checking account deposits is $40,000.

Calculate the maximum increase in money supply -

Maximum increase = Initial excess reserves created * money multiplier = $3,600 * 10 = $36,000

The maximum increase in money supply is $36,000.

The maximum increase in checking account deposits and the maximum increase in money supply are not equal because initial deposit was made from the currency.

Currency and checking deposits are part of money supply.

So, initial deposit of $4,000 is just conversion of currency into checking account and thus is already part of money supply.

Any addition after that would be an increase in money supply.

$36,000 are created after that. So, money supply has increased by $36,000 and thus is not equal to increase in checking account deposits.