【only this question】Based on your answers for 1a. and 1b. above, make a general statement regarding...

【only this question】Based on your answers for 1a. and 1b. above, make a general statement regarding how interest rates on loans and reserve requirements affect the opportunity cost to banks of holding required reserves.

( 1a In the years before 2008, the FED did not pay interest on bank reserves. For every $100,000 in checkable deposits, how much did banks lose in forgone interest (opportunity cost) because of reserve requirements if banks charged 8% on their loans and the required reserve ratio was 10%?

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1b For every $100,000 in checkable deposits, how much did banks lose in forgone interest (opportunity cost) because of reserve requirements if banks charged 12% on their loans and the required reserve ratio was 20%? )

Expert Solution

Federal Reserve, interest on loan and opportunity cost

Federal Reserve: - Banks are required to maintain a certain % of their deposits in reserve so that it can be used for unwanted condition and avoid abnormal fluctuation of economy. The rate of reserve decides by Government.

Interest on loan: - Rate of Interest on loans is depends on availability of funds in banks. If funds are largely available in bank, interest rates will get reduced and banks want to distribute loans as much as they can. In case of shortage of funds banks enhance the rate of interest of deposits and borrowings.

Opportunity Cost of Reserve:- Banks are required to maintain reserve on reserve normally banks does not earn any interest however they have opportunity to give such amount as loan to borrowers this lost opportunity cost of earning interest is called Opportunity cost of Reserve. Whenever reserve percentage raises rates of interest of deposit and loans get increased and vice versa.

It can be seen that all above three terms are interrelated with each other and affect and control mutually. Government use Reserve as a tool to control interest rates, loans and deposits.

General Statement on interest on loan and reserve requirement affect opportunity cost of Reserve:-

Interest on loan and reserve requirement have parallel relation with opportunity cost of Reserve. If Interest on loan and reserve requirement are higher, opportunity cost of Reserve will also be at higher side and vice-versa.

jeff jeffy answered 1 year ago

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