1) Table Il shows the balance sheet of UOUBC Bank: Table ll: Balance Sheet of UQ

Question

1) Table Il shows the balance sheet of UOUBC Bank: Table ll: Balance Sheet of UQUBC Bank Assets Liabilities Loans Required reserves $4 million Excess reserves Bonds Suppose all other banks in the economy followed the same required reserve ratio as UOUBC, no banks hold excess reserves, and the public holds all of their money in the form of deposits. If $10 million in deposits is withdrawn from UOUBC and does not enter any other bank, by how much would total deposits in the economy decline? $16 million Deposits $20 million $0 $5 $5 million

Explanation / Answer

Required reserve ratio = $4M/$20M = 20%

Let’s start with the following assumptions:

Since, the banks must keep some deposits as reserves, the further lending it can be involved in is limited. So if we start with $1,000 and reserve ratio as 20%, then the series of transactions look like the following:

$1,000

$800

$640

….

The above series of number is nothing but a GP

Hence, the total quantity of money that is circulated is $1000/0.2 = $5,000

Applying the same hypothesis on the problem at hand, we see that since $10M is withdrawn, total amount that can be circulated = $10M/20% = $50M

Now since, the above money is not deposited into any other bank so from above, we deduce that the money would not be circulated and hence there will be a decline of currency in the economy.

Therefore, total decline would be $50M

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