Assume all banks have the same reserve requirement, 10% and you just remember yo
ID: 1110234 • 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 Using the $1,000 deposit and reserve requirement is still 10%, suppose I tell you that in each round, 10% is withdrawn for cash and this is a leakage.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
Amount of deposit in the bank is $1000 ad required reserve rate is 10% or 0.1, i,e. the bank has to keep $10% of each amounts of deposit.
a. Deposit in first phase is $1000. Among which $100 reserve and $900 is used as loan to the borrowers. In the next stage $900 is the deposits and $90 is the researve. Therefore, $810 is the amount of loan and so on.
total deposits = (1000 + 900 +810 + ....) the process will continue until the exhausion of the excess reserve.
= 1000 (1+ .9 +.81 + ...) = 1000* 1/(1-0.9) = 1000* 1/0.1 = 10* 1000 = $10000
Total amount of deposits in the banking system is $10000.
b. Total amount of reserve = D * RR = 10000* 0.1 = $1000
Amount of loan creared in the economy= $10000- $1000 = $9000
c. Leakage = 10% and reserve.
Multiplier: M /H = C + D/ (C + R) = (c+1)/ (c+x) = (0.1 + 1)/ (0.1+ 0.1) = 1.1/0.2 = 5.5
Researve ratio now x= 1/5.5 = 0.18
Total Deposit at the end of the process = 1000 * 1/ 0.18 = $5555.56
d. Total deposit created in the economy reduced in part 'c' due to leakage in the money supply. As people incraeses cash hol,ding by 10%, the strength of money multiplier decreases and hence, deposits in banking system decraeses at each stage. Therefore, ability of the banks to create loan also decraeses. As a result, total deposits in the banking reduced from $10000 to $5555.56 with same reserve ratio.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.