Assume all banks have the same reserve requirement, 10% and you just remember yo
ID: 1109536 • Letter: A
Question
Assume all banks have the same reserve requirement, 10% and you just remember you buried $1,000 in your backyard 2 years ago. You take the thousand dollars to your bank and deposit it. a) When the rounds have been exhausted, what is the total amount of deposits in the banking system? Show and explain. b) Using the total deposit number, show the amount of required reserves created and the amount of loans created by this process. c) You will have to think a bit about this one. Using the $1,000 deposit and reserve requirement is still 10%, suppose I tell you that in each round, 10% is withdrawn for cash and this is a leakage. Show and explain what is the multiplier now and what would be total deposits at the end of the process. d) From parts ‘a’ and ‘c’, what has happened and why? e) What is the size of the FOMC and where do they come from?
Explanation / Answer
a) reserve ratio=10%= 10/100=0.1
Demand deposit multiplier=1/reserve ratio=1/0.1= 10
The total time=1 year
Therefore, the total amount of deposit=1000×10××1= $10000
b) the required reserve is the demand deposit multiplied to the reserve ratio= total demand deposit×reserve ratio= 10000×0.1= 1000
Since, commercial banks don't hold free or excess reserves hence, they stand fully loaned. Thus, in this case the the amount of loans is also 1000.
c) total amount of deposit in 1years = 10000
Leakage= 10% of the deposit (initial) =(10×1000)/100=100
1year=12 months
The total leakage in 1years= 100×12= 1200
The total deposit now=10000-1200=8800
Therefore the reserve ratio= 1000/8800= 0.114
Therefore, the multiplier=1/0.114= 8.8
d) The money when deposited in (a) went through the first round and the reserve was 1000. The money in (c) due to leakage is lost from the reserve and the multiplier changes from 10 in (a) to 8.8 in (c).
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