Question

2. The Iron Bank is the only bank in the economy; they have 200m of deposits and a required reserve ratio of 10%. Their assets are one-half in loans to business and one-half government bonds.

a. Draw their initial T-table of Assets and Liabilities. How many assets do they have, once the money multiplier has completed?

b. Next suppose the central bank purchases 2m of bonds from the Iron Bank. Show the key steps as their T-table adjusts. What is the final change in money?

c. The central bank reverses policy and instead sells 2m of bonds to the Iron Bank. Again show the key steps. What is the final change in money?

Answer 1

Solution:

(2).

Given bank information,

(A) initial T-table of Assets and Liabilities. How many assets do they have, once the money multiplier has completed:

here the bank have “200 M” of deposits and the required reserve ratio is “10%”.

So,

the initial “t-table” is given by:

ASSETS	LIABILITIES
RESERVES = 10%of 200 mil = 20 million	Deposits = $200 M
Loan to business = 0.90*200/2 = $90
Loan to Government = 0.90*200/2 = $90
Total loan = $200 M

Here in liabilities ,

Total liabilities = $200 M

So, the above table is the initial “t-table”, where both the sides are equal.

So, to find out the total assets of the bank we need to fig out the total money supply.

Now, here the “required reserve ratio is “10%”,

=> the money multiplier is “1/0.10=10”.

So,

the money supply is given by, => D/0.10

= 200 M / 0.10

= $2,000 M.

So,

the total asset once the multiplier is complete is given by “$2,000 M”.

(B).suppose the central bank purchases 2m of bonds from the Iron Bank. Show the key steps as their T-table adjusts. What is the final change in money:

Now, consider the case that the Central Bank purchased “2 M of bonds” from the Iron Bank,

=> this amount is included in Banks “Liability side”.

So, here the “t-table” is given by:

ASSETS	LIABILITIES
RESERVES = 10%of 202 mil = 20.2 million	Deposits = $200 M
Loan to business = 0.90*202/2 = $90.9
Loan to Government = 0.90*202/2 = $90.9
Total loan = $202 M

Here in liabilities,

Bonds = $2 M

Total = $202 M

So, here the total Liability is “$202 M”,

=> if the money multiplier is “1/0.10 = 10”,

=> the money supply is given by, “$202 M / 0.10

= $202 M * 10

= $2020 M”.

So, the change is money supply is “2020 - 102

= $1,918 M.

(C).central bank reverses policy and instead sells 2m of bonds to the Iron Bank. Again show the key steps. What is the final change in money:

Now, consider the case that the Central Bank sells “2 M of Bond” to Iron Bank,

=> the new “t-table” is given by:

ASSETS	LIABILITIES
RESERVES = 10%of 198 mil = 19.8 million	Deposits = $200 M
Loan to business = 0.90*198/2 = $89.1
Loan to Government = 0.90*198/2 = $89.1
Total loan = $198 M

Here in liabilities,

Bonds = -$2 M

Total = $198 M

So, the money supply sis given by, “198/0.10 = 1980”,

=> the final change in money supply is given by, “$1980 - $198 = $1,782”.