Question

Let’s say that Wakanda decides to form a government. The government is deciding on how much money to release into the economy. Their central bank releases $1,000 into the economy and allows banks to form and start taking deposits and making loans. The central bank also sets a reserve requirement ratio of 0.6.

1. Assume 15 loans have been made. The banks do not keep excess reserves. What is the amount loaned out for the 16th loan? (Show work)

2. After all loans have been made, the equilibrium price level is set at $100. Draw the money market graph for Wakanda. (Label with specific values).

3. Let’s say Wakanda’s central bank continues to buy bonds. What affect will this have on GDP in short run? (Explain)

Answer 1

a. Banks keep reserve ratio is 0.6, so if government makes a deposit of $1000, the bank keeps $600 as reserves and lends out $400.
Now since $400 is lent out, other banks will see future deposits of $400, out of which $240 is kept as reserves and $160 is lent out. This cycle continues.

After the 15th loan, the amount left for making the 16th loan is

The amount of loan made out for the 16th time is manually calculated as = 1000*(0.4)¹⁶ = $0.000429.

From the excel screenshot, the working can be explained as:-
For the 16th row, deposit will be the amount previously loaned out, ie $0.001074.
Out of which 0.6 is kept as reserves, i.e. 0.001074*0.6 = $0.000644.
Amount loaned out = Deposits - Reserves = $0.001074 - $0.000644 = $0.000429

b.

c. When the central bank of Wakanda buys bonds, it increaes the money supply of the economy, because it swaps bonds in exchange for cash to the public. An increase in money supply then leads to an increase in the nominal output, or GDP. This is because increased money supply leads to higher consumer spending, lower interest rate and therefore an increase in the aggregate demand.