Question

Week 4 Project - Submit Files Hide Submission Folder Information Submission Folder Week 4 Project Instructions Changes in Monetary Policy Assume that the Bank of Ecoville has the following balance sheet and the Fed has a 10% reserve requirement in place: Balance Sheet for Ecoville International Bank ASSETS LIABILITIES Cash $33,000 Demand Deposits $99,000 Loans 66,000 Now assume that the Fed lowers the reserve requirement to 8%. What is the maximum amount of new loans that this bank can make? Assume that the bank makes these loans. What will the new balance sheet look like? By how much has the money supply increased or decreased? If the money multiplier is 5, how much money will ultimately be created by this event? If the Fed wanted to implement a contractionary monetary policy using reserve requirement, how would that work? Submission Details: Address the questions above, showing your calculations. Develop your analysis in Microsoft Excel format. Enter non-numerical responses in the same worksheet using textboxes. Name your document SU_ECO2072_W4_LastName_FirstInitial. Submit your document to the Submissions Area by the due date assigned. If you want to learn how to use Microsoft Excel, refer to the MS Excel tutorial link. Due Date

Answer 1

a)

The bank is only required to keep 10% of the demand deposits as reserves. 10% of $99000 is $9900. The bank can therefore make loans up to $99,000 - 9900 = $89,100.

But it has actually made loans worth $66,000. So even with no change in the required reserve ratios the bank can still make additional loans worth $23,100.

If the Fed reduces the required reserve ratio to 8%, the bank is now required to keep 8% of $99,000, or $7920. The bank can then make loans worth $99,000 - 7920 =$91,080.

The bank has already made actual loans worth $66,000 so it can further loan out $91,080-66,000 = $25,080.

b)

If they made these loans, the balance sheet would look like this:

Assets
Cash: $7,920
Loans: $91,080

Liabilities
Demand Deposits: $99,000

c)

If the bank actually loans out as much as allowed, then the initial increase in money supply is $25,080. The final increase when all rounds have been completed will be determined by the money multiplier that is given by 1/r, where r is the required reserve ratio. Given that r is 8%, the multiplier is 1/0.08 = 12.5. Hence, the increase in money supply is 12.5 x 25,080= $313,500.

d)

Increase in money supply is 5 x 25,080= $125,400.

e)

It would increase reserve requirement ratio so as to contract money supply in the economy.