Question

a) Show the changes to the balance sheets for commercial banks when the Federal Reserve buys $50 million in US Treasury Bills. If the public holds a fixed amount of currency ( so that all loans create an equal amount of deposits in the banking system), the minimum reserve requirement is 5%, by how much will checkable bank deposits in commercial banks change?

b) Now suppose that the Fed raises the discount rate significantly. How would you expect this to affect the balance sheet of local banks? Is this likely to decrease or increase M1?

Answer 1

1)The deposits in the commercial banks will rise by $50 million kinds of like a check also balance considering the bank’s assets also liabilities will both rise by that value.
The cash supply will vary by $1,000 million ($50 mn / 5%) because purchasing the $50 million in depository bills will set them above the number of reserves the banks transfer up in plenty.
Balance sheet

Assets	Liabilities
Treasury Bills = -$50 million
Reserves =+50 million	Checkable deposits=+1000 million
Loans = +1,000 million

2)

• The discount rate is the interest rate the central bank imposes commercial banks that require to acquire further reserves.
• This is an authorized interest rate introduced by the Fed, not a market rate; consequently, enough of its significance stems of the signal the Fed is transferring to the economic markets (if it's low, the Fed needs to support spending also vice versa).
• Being a consequence, short-term market interest rates lead to follow its progress. If the Fed needs to provide banks more extra reserves, it can decrease the interest rate it imposes, through attractive banks to acquire higher.
• Alternatively, it can dry up reserves by increasing its rate and urging the banks to decrease financing.