In: Economics
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
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