Question

Bank Assets      Bank Liabilities  

Total Reserves $500,000,000 Demand Deposits $500,000,000

Loans

Government Bonds                

Total $500,000,000 $500,000,000

Answer the following in successive order..

If the required reserve ratio is set at 20% by the FED

1. How much must the bank put into it's required reserves?

2. How much will be left in excess reserves?

3. How much can the bank lend at max?

4. At maximum lending, then the money multiplier will be equal to?

5. At maximum lending, the money supply in the economy will increase by how much?

6. If the bank buys $100,000,000 in government bonds, how much will it have available to loan to individual and businesses?

7. After the bank buys the government bonds, how much can the money supply increase?

Answer 1

1. Required reserves= required reserves ratio * demand deposits

= 20% * 500,000,000=$ 100,000,000

2. Excess reserves = total reserves - required reserves

= 500,000,000-100,000,000 = 400,000,000

3. The maximum a bank can lend is the whole of excess reserve.

Maximum a bank can lend =$ 400,000,000

4. Money multiplier = 1/reserve ratio

=1/.20 = 5

5. Maximum increase in money supply = maximum lending * money supply.

= 5 * 400,000,000

= $ 2,000,000,000

6. Money put in government bonds = 100,000,000.

New excess reserves = 400,000,000 - 100,000,000 = $300,000,000 = The maximum amount available to loan to business and individuals.

7. Increase in money supply = money multiplier * maximum (new) lending

= 5 * 300,000,000

= $1,500,000,000