For the following questions, assume that the FED\'s main assets are T-securities

Question

For the following questions, assume that the FED's main assets are T-securities and discount loans provided to banks. Its main liabilities are notes in circulation and bank reserves. 1. Suppose that the FED conducts an open market sale of $2000 to the Washington National Bank. a. How will this affect the assets and liabilities of the FED? b. How will this affect the assets and liabilities of Washington National Bank? c. How will this affect the monetary base of the economy? d. Assuming that the reserve requirement for all banks is 10%, how will this affect the monetary aggregate Ml? 2) A bank has excess reserves of $6,000 and demand deposit liabilities of $100,000 when the required reserve ratio is 20 percent. If the reserve ratio is raised to 25 percent, the bank's excess reserves will be A) -$5,000. B) -$1,000. C) $1,000. D) $5,000. 3) If reserves in the banking system increase by $100, then checkable deposits will increase by $2,000 in the simple model of deposit creation when the required reserve ratio is A) 0.01. B) 0.05. C) 0.10. D) 0.20.

Explanation / Answer

1. a. Assets of FED will decrease as securities of 2000 decrease.

Liability of FED will decrease as reserves of 2000 decrease.

b. Assets of Washington National Bank will remain same as securities increase by 2000 and reserves decrease by 2000. Liability of Washington National Bank is unchanged

c. Monetary base of economy will decrease by 2000.

d. M1 will decrease by multiplier = 1/Reserve ratio = 10.

So M1 will decrease by 10*2000 = 20000

2. Reserves = 6000 + 0.20*100,000 = 26000

If reserve requirement = 0.25*100,000 = 25,000

Excess reserves = 26000 - 25000 = 1000

C. 1000

3. Multiplier = 2000/100 = 20

Reserve ratio = 1/multiplier = 0.05

B. 0.05

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