Reference no: EM132766984

Assume that a bank has the following simplified balance sheet, and is operating at its desired liquidity ratio.

Liabilities (£m)                    Assets (£m)

Deposits 100           Balances with the central bank 10

                                     Advances 90

100                                         100

Now assume that the central bank repurchases £5 million of government bonds on the open market. Assume that the people who sell the bonds all have their accounts with this bank.

Problem (a) Draw up the new balance sheet directly after the purchase of the bonds.

Problem (b) Now draw up the eventual balance sheet after all credit creation has taken place.

Problem (c) Would there be a similar effect if the central bank rediscounted £5 billion of Treasury bills?

Problem (d) How would such open market operations affect the rate of interest?