Question

Walter White “found” $1,000,000 and deposited it into his checking account at Wells Fargo Bank. Answer the following questions in response to this new $1,000,000 in checkable deposits. The reserve ratio is 8 percent.

a. What is the max. amount of new loans Wells Fargo Bank can make (i.e. excess reserves, E)?

b. What is the size of the monetary multiplier, m?

c. Calculate maximum checkable-deposit creation, D.

d. Answer questions a,b,c on the assumption that the reserve ratio is 5 percent.

e. In response to the economic shutdown caused by the COVID-19 pandemic, The Federal Reserve's new corporate-credit facility took in $305 million worth of exchange-traded funds on the first day of its operation, according to data released Thursday

▪ Briefly explain the cause-effect chain from this specific expansionary monetary policy (i.e. the Fed buying corporate-debt ETFs), and how the Fed expects this action to boost real GDP in the U.S. economy. You can simply view this as a form of quantitative easing.

Answer 1

a) Required reserves are certain percentage of the deposits of the bank which it is required to keep with itself in the form of reserves. Excess reserves are the amount which is over and above the required reserves. This amount can be used by the bank to make loans and advances.

Deposit= $1,000,000. Required reserve ratio= 8%

Required reserves= required reserve ratio x deposits

Required reserves= 8% x $1,000,000

Required reserves= 8/100 x $1,000,000

Required reserves= 0.08 x $1,000,000

Required reserves= $80,000

Hence, when Wells Fargo bank will receive a deposit of $1,000,000 from White Walter, $80,000 will be kept as required reserves and the rest ( excess reserves) will be used to give loans.

Excess reserves= deposit - required reserves

Excess reserves=$1,000,000 - $80,000

Excess reserves= $920,000

Hence, the maximum amount of new loans (excess reserves) that the Wells Fargo bank can make is $920,000.

b) Money multiplier tells us by how many times the money supply will increase as a result of an initial deposit made.

Money multiplier= 1/RR

(where RR is the required reserve ratio)

Money multiplier= 1/8%

Money multiplier= 1/0.08

Money multiplier= 12.5

Hence, the size of money multiplier is 12.5. This means that as a result of an initial deposit made, the money supply will increase by 12.5 times.

c) The maximum checkable deposit creation can be calculated as-

New deposits= 1/RR x D

( Where RR is the required reserve ratio and D is change in initial deposit)

New deposits= 1/8% x $1,000,000

= 1/0.08 x $1,000,000

= 12.5 x $1,000,000

New deposits= $12,500,000

Hence, the maximum checkable deposit creation is $12,500,000.

d) when reserve ratio is 5%-

a) Required reserves= required reserve ratio x deposits

Required reserves= 5% x $1,000,000

Required reserves= 5/100 x $1,000,000

Required reserves= 0.05 x $1,000,000

Required reserves= $50,000

Hence, when required reserve ratio is 5%, Wells Fargo bank will keep a required reserves of $50,000 when a deposit of $1,000,000 is received.

Excess reserves= deposit - required reserves

Excess reserves= $1,000,000 - $50,000

Excess reserves= $950,000

Hence, when the required reserve ratio is 5%, the maximum amount of new loans that Wells Fargo bank can make is $950,000.

b ) Money multiplier tells us by how many times the money supply will increase as a result of an initial deposit made.

Money multiplier= 1/RR

When required reserve ratio= 5%

Money multiplier= 1/5%

Money multiplier= 1/0.05

Money multiplier=20

Hence, when the required reserve ratio is 5%, the size of money multiplier is 20.

c) The maximum amount of checkable deposit creation can be calculated as-

New deposits= 1/RR x D

( Where RR is the required reserve ratio and D is change in initial deposit)

Here,. RR= 5%

New deposits= 1/5% x $1,000,000

New deposits= 1/0.05 x $1,000,000

New deposits= 20 x $1,000,000

New deposits= $20,000,000

Hence, the maximum checkable deposit creation when required reserve ratio is 5% is $20,000,000.