Question

1. Consider the balance sheet for the Wahoo bank as presented below.

Wahoo Bank Balance Sheet
Assets		Liabilities
government securities	$1,600	Liabilities:                     Checking accounts	$4,000
Required Reserves	$400	Net Worth	$1,000
Excess Reserves	$0
Loans	$3,000
Total Assets	$5,000	Total Liabilities	$5,000

Using a required reserve ratio of 10% and assuming that the bank keeps no excess reserves, write the changes to the balance sheet for each of the following scenarios:

1. Bennett withdraws $500 from his checking account.
2. The Fed buys $1,000 in government securities from the bank.

4) Using a required reserve ratio of 10% and assuming that banks keep no excess reserves, which of the following scenarios produces a larger increase in the money supply, explain why.

a) Someone takes $1000 from under his or her mattress and deposits it into a checking account.

b) The Fed purchases $1,000 in government securities from a commercial bank

Answer 1

It is given that required reserve ratio is 10% of deposits

There is no excess reserves.

a) When Bennett (Public) withdraws $500 from checking account:

The checking account deposits would go down by $500

The required reserves will go down by 10%*$500 = $50

The loans would go down by $450

Hence, the result is:

Wahoo Bank Balance Sheet
Assets		Liabilities
government securities	$1,600	Liabilities:                     Checking accounts	$3,500
Required Reserves	$350	Net Worth	$1,000
Excess Reserves	$0
Loans	$2,550
Total Assets	$4,500	Total Liabilities	$4,500

b) When Fed buys $100 in government securities from the bank, Bank's holding of government securities would go down by $1000

The required reserves is 10% Hence, required reserves would go up by 10%*$1000 = $100

Hence, the completed table is:

Wahoo Bank Balance Sheet
Assets		Liabilities
government securities	$600	Liabilities:                     Checking accounts	$5,000
Required Reserves	$500	Net Worth	$1,000
Excess Reserves	$0
Loans	$3,000
Total Assets	$4,100	Total Liabilities	$6,000

4) It shall be noted that with required reserves of 10% with no excess reserves, when someone takes $1000 from under mattress and deposits it into checking account, it will result in creation of money with the process of loan creation.

The checking deposit forms the basis of the reserves that the bank use to create loan and hence, money supply.

Given the required reserves of 10%, 90% of $1000 as reserves is available with the bank that can be used for loan creation.

The purchase of $1000 worth of government securities from commercial banks will not affect the loan creating capacity of the bank.