What is the reserve-deposit ratio of banks

Reference no: EM132179247

Problem - Consider the balance sheet of the Federal Reserve

Asset		Liabilities
Securities	$4,800	Currency	$4,000
Gold	$200	Reserve Deposit	$1,000

There are many banks in the economy, but we will combine all the banks together. Suppose their consolidated balance sheet looks like:

Asset		Liabilities
Reserve Deposit	$1,000	Deposit	$20,000
Loan	$19,000

(1) What is the money supply and monetary base in the economy?

(2) What is the reserve-deposit ratio of banks and the currency-deposit ratio in the economy? Calculate the money multiplier in this economy.

(3) Suppose the Fed wants to increase the money supply in the economy. The Fed buys $2,000 of securities from an investor who has a bank account at Bank of America. The Fed receives $2,000 in securities from the investor and pays for these securities by increasing Bank of America's deposit account at the Fed by $2,000. Bank of America then increases the investor's account balance at Bank of America by $2,000. Write down the bank balance sheets of the Fed and the consolidated bank after this transaction.

(4) The bankers want to maintain there reserve-deposit ratio of 5%, and lend the rest to Ally. What would be the amount of the loans?

(5) Suppose Ally uses the loan to buy some goods from John. Then, John deposits the money to Citibank. How will the balance sheets change?

(6) The new bank balance sheet may still show the higher reserve-deposit ratio than 5%. If banks maintain the reserve-deposit ratio at 5% and keep lending the excess reserve (that is, bank repeat (4) and (5) again and again), what would be the final amount of deposit that bank will hold?

(7) Compare part (1) and (6) What is the additional money supply created by the Fed's open market purchase of $2,000 securities?

(8) What is the new currency-deposit ratio in the economy? Calculate the new money multiplier. Is it higher or lower than part (2)?

Reference no: EM132179247

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