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Q.3. The table below shows the initial T-account for a bank. ASSETS LIABILITIES Reserves $1,000 Deposits...

Q.3. The table below shows the initial T-account for a bank.

ASSETS LIABILITIES

Reserves $1,000 Deposits $5,000

Loans $4,000

Assume the reserve ratio required by FED is 20% and the bank tries to maximize profits by loaning out the maximum amount allowed by FED.

a. What is the size of the multiplier?

b. How much total money can be created by the banking system in this scenario? (Please show your calculations ).

Q-1 Suppose that the T- account for First National Bank is as follows and the reserve requirements ratio is 10%

ASSETS LIABILITIES

Cash Reserves $ 1,000 Demand Deposits $10,000

Loans $ 9,000

$ 10,000 $10,000

What is the size of the money multiplier?
With the present required ratio how much total money banking system can create (show your work)?

Expert Solution

Q3)

a) Money multiplier tells us that by how many times the money supply will increase as a result of an initial deposit made. We know that a bank's power to create credit is limited by the size of required reserves, hence, money multiplier is the inverse of required reserve ratio. It is calculated as-

Money multiplier = 1/ RR

( Where RR is the required reserve ratio)

Money multiplier = 1/ 20%

Money multiplier = 1/(20/100)

Money multiplier = 1/0.2

Money multiplier = 5

Hence, the size of money multiplier is 5. ( Answer)

b). The required reserve ratio is 20% . It means that banks are required to keep 20% of their deposits as required reserves and will loan out the excess reserves. This excess reserve ( loan) loaned out by one bank will again get deposited in another bank and the same process of depositing and lending will continue to take place in the whole banking system until the last amount deposited is too small to make a loan. Hence, as a result of an initial deposit made, the total amount of money generated in the banking system as a whole can be calculated as-

New deposits = 1/RR x D

( Where RR is the required reserve ratio and D is change in Initial deposit)

New deposits= 1/20% x $5,000

New deposits= 1/(20/100) x $5,000

New deposits= 1/0.2 x $5,000

New deposits= 5 x $5,000

New deposits = $25,000

New deposits = $25,000

Hence, the total amount of money created by the banking system is $25,000 ( answer).

Rahul Sunny answered 2 years ago

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