Question

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MHM Bank currently has $750 million in transaction deposits on its balance sheet. The current reserve...

MHM Bank currently has $750 million in transaction deposits on its balance sheet. The current reserve requirement is 8 percent, but the Federal Reserve is increasing this requirement to 10 percent.

a.

Show the balance sheet of the Federal Reserve and MHM Bank if MHM Bank converts all excess reserves to loans, but borrowers return only 60 percent of these funds to MHM Bank as transaction deposits. (Enter your answers in millions. Do not round intermediate calculations. Round your "Panel B" answers to 3 decimal places. (e.g., 32.161))

Panel A: Initial balance sheets

Federal Reserve Bank
Assets		Liabilities
(Click to select)LoansReserve accountsSecuritiesReserve deposits at FedTransaction deposits	$ million	(Click to select)Reserve accountsReserve deposits at FedTransaction depositsSecuritiesLoans	$ million

MHM Bank
Assets		Liabilities
(Click to select)LoansTransaction depositsSecuritiesReserve accountsReserve deposits at Fed	$ million	(Click to select)LoansReserve deposits at FedReserve accountsSecuritiesTransaction deposits	$ million
(Click to select)Reserve deposits at FedTransaction depositsSecuritiesReserve accountsLoans	$ million

Panel B: Balance sheet after all changes

Federal Reserve Bank
Assets		Liabilities
(Click to select)SecuritiesTransaction depositsLoansReserve accountsReserve deposits at Fed	$ million	(Click to select)SecuritiesReserve accountsLoansTransaction depositsReserve deposits at Fed	$ million

MHM Bank
Assets		Liabilities
(Click to select)Reserve accountsLoansSecuritiesTransaction depositsReserve deposits at Fed	$ million	(Click to select)LoansTransaction depositsReserve accountsReserve deposits at FedSecurities	$ million
(Click to select)SecuritiesLoansTransaction depositsReserve accountsReserve deposits at Fed	$ million

b.

Show the balance sheet of the Federal Reserve and MHM Bank if MHM Bank converts 70 percent of its excess reserves to loans and borrowers return 80 percent of these funds to MHM Bank as transaction deposits. (Enter your answers in millions. Do not round intermediate calculations. Round your "Panel B" answers to 3 decimal places. (e.g., 32.161))

Panel A: Initial balance sheets

Federal Reserve Bank
Assets		Liabilities
(Click to select)LoansSecuritiesReserve deposits at FedReserve accountsTransaction deposits	$ million	(Click to select)SecuritiesReserve deposits at FedLoansTransaction depositsReserve accounts	$ million

MHM Bank
Assets		Liabilities
(Click to select)SecuritiesLoansReserve deposits at FedTransaction depositsReserve accounts	$ million	(Click to select)LoansTransaction depositsReserve deposits at FedSecuritiesReserve accounts	$ million
(Click to select)LoansTransaction depositsReserve deposits at FedReserve accountsSecurities	$ million

Panel B: Balance sheet after all changes

Federal Reserve Bank
Assets		Liabilities
(Click to select)Reserve deposits at FedLoansTransaction depositsSecuritiesReserve accounts	$ million	(Click to select)LoansReserve deposits at FedTransaction depositsSecuritiesReserve accounts	$ million

MHM Bank
Assets		Liabilities
(Click to select)Transaction depositsLoansSecuritiesReserve accountsReserve deposits at Fed	$ million	(Click to select)Reserve accountsLoansSecuritiesTransaction depositsReserve deposits at Fed	$ million
(Click to select)Reserve accountsSecuritiesReserve deposits at FedTransaction depositsLoans	$ million

Expert Solution

Part-a:

Panel A: Initial Balance Sheets: (IN MILLIONS)
FED
Assets- Securities: $60
Liabilities- Reserve Accounts: $60

MHM Bank
Assets- Loans: $690
Reserve Deposits at Fed: $60
Liabilities- Transaction deposits: $750

Panel B: After All Changes: (IN MILLIONS)
FED
Assets- Securities: $72,5
Liabilities- Reserve Accounts: $72,5

MHM Bank
Assets- Loans: $652.500
Reserve Deposits at Fed: $7.5
Liabilities- Transaction deposits: $725.000

Working notes

New initial required reserves = 0.10 × $750 million = $75 million

Change in bank deposits = (1/(0.10 + (1 ? 0.50)))X ($60 million - $75 million) = ?$ 25 million

Loans: $725 million ? $72.5 million = $652.500million

Transaction deposits: $750 million + (?$15 million × (1/(0.10 + 0.50))) = $725.000 million

Reserve deposits at Fed: $725 million × 0.10 = $72.5 million

Part-b

Panel A: Initial Balance Sheets: (IN MILLIONS)
FED
Assets- Securities: $60
Liabilities- Reserve Accounts: $60

MHM Bank
Assets- Loans: $690
Reserve Deposits at Fed: $60
Liabilities- Transaction deposits: $750

Panel B: After All Changes: (IN MILLIONS)
FED
Assets- Securities: $70.2
Liabilities- Reserve Accounts: $70.2

MHM Bank
Assets- Loans: $631.80
Reserve Deposits at Fed: $70.2
Liabilities- Transaction deposits: $702.00

Working notes -:

New initial required reserves = 0.10 × $750 million = $75 million
Change in bank deposits = (1/(0.10 + (1 ? 0.85))) × ($60 million - $75 million) × 0.80 = ?$48.000 million
Loans:$702.000 million ? $70.200 million = $631.80million
Transaction deposits:$750 million + (?$15 million × 0.80 × (1/(0.10 + 0.15))) = $702.00 million
Reserve deposits at Fed:$702.00 million × 0.10 = $70.2 million

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