Question

34. On May 1, Jobs Bank (JB) holds $200 million in deposits and is required by the Federal Reserve to maintain a reserve ratio of 12.5%. JB holds twice the minimum of amount of reserves required by the Federal reserve.

Part 1: Show a T-account for JB on May 1.

Part 2: On May 5, JB’s largest depositor, Switzer, withdraws $20 million from her account. (a) Show JB’s T-account immediately after Switzer withdraws $20 million from her account. (b) Immediately after the withdrawal, does JB meet the Federal Reserve requirement? (c) What amount of reserves is JB required to hold after the withdrawal?

Part 3: Suppose that JB's second largest investor, Lannister, finds $10 million in her couch cushions and deposits the full $10 million with JB. If JB continues to hold twice the amount of the minimum amount reserves required by the Federal Reserve, what is the largest amount that the money supply can increase by? What is the smallest amount?

Answer 1

Part 1

On May 1, Deposits is $200 million. Reserve Requirements 12.5% but Bank is holding twice i.e 12.5%*2 = 25%.

Hence Reserves = 25% *200 = 0.25*200=$50 million

Rest the Bank will lend, i.e 200-50 =$150 million

Hence T Account will be as follows:

Assets Liabilities

Reserves $50 million Deposits $200 million

Loans $150 million

Total Assets $200 million Total Liabilities $200 million

Part 2

After Withdrawal of $20 million, new deposit will be 200-20 =$180 million

Reserves will reduce by $20 million, i.e new Reserves = 50-20=$30 million

New T Account will be

Assets Liabilities

Reserves $30 million Deposits $180 million

Loans $150 million

Total Assets $180 million Total Liabilities $180 million

Federal Reserve Requirement is 12.5% i.e 12.5%*180 = $22.5 million while bank is holding $30 million. Hence Bank is meeting Fed Requirement.

Bank is required to hold Reserve of $22.5 million after withdrawal as shown above.

Part 3

If $10 million is deposited by Lannister, New Deposits will be 180+10= $190 million

Hence Twice the Reserve Requirement is 25%, i.e 25% * 190 = $47.5 while Bank last Reserve was $30 million.

Hence Bank will need extra 47.5-30 =$17.5 million to keep twice reserves while deposit is made of $10 million.

Hence Bank will need more 17.5-10=$7.5 million of money to maintain reserve of twice the requirements. Thus Bank will not be able to lend any extra money after the deposit. Hence there will be no increase in money supply.