Question

In: Economics

True or False. Graph if needed. explantion please! A6-6. Suppose the Bank of Canada (BOC) buys...

True or False. Graph if needed. explantion please!

A6-6. Suppose the Bank of Canada (BOC) buys $10B worth of bonds from the Canadian banking system that operates with a desired reserve ratio of 5%. Immediately after the transaction, the balance sheet of the BOC expands by $10B, while balance sheet of the banking system is the same size, but in the long run, the balance sheet of both the BOC and the banking system expand by $200B

Solutions

Expert Solution

Solution: FALSE

Working:

The banking systems reserve ratio was 5% originally however after the purchase it changes to 36% (=$11B/$30B). Since the banking system only desires a 5% reserve ratio than 5% of $30B will be computed $1.5B. Thus an amount of $9.5B (=11B – 1.5B) will be in excess reserves with 30B in deposits. Now assuming they lend all of it i.e. $9.5B, thus will increases Loans by $9.5B however reduces its cash reserves by the same amount. Thus the target reserve ratio equals 0.05. So total deposits in the banking system will eventually increase by 20 times (= 1/0.05) which equals $200B (= $10B x 20). Hence the balance sheets of the banking system will expand by $200B in the long-duration.

BOC

BS

Assets

Amount

Liabilities

Amount

Assets

Amount

Liabilities

Reserves

5

Deposits

12

Reserves

1

Deposits

20

Loans

10

Capital

3

Loans

24

Capital

5

15

15

25

25

After purchase

After purchase

Assets

Amount

Liabilities

Amount

Assets

Amount

Liabilities

Reserves

5

Deposits

12

Reserves

11

Deposits

30

Loans

10

Capital

3

Loans

24

Capital

5

15

15

35

35

After loan

Assets

Amount

Liabilities

Reserves

1.5

Deposits

30

Loans

33.5

Capital

5

35

35

From above computations we can conclude that although the long-run part is true, however the immediate effect on the balance sheets is false


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