3. Suppose an economy where all tansactions are made using checks of their debit

Question

3. Suppose an economy where all tansactions are made using checks of their debit cards. No one carries currency in this economy. The central bank requires holding 10% of deposits as reserves. The following table provides the initial T-accounts of First National Bank ASSETS LIABILITIES 40,000 S160,000 $200,000 Reserves sits $400,000 Treasury bills Loans Suppose that the central bank in this economy purchases S50,000 worth of Treasury bills from First National Bank. How much in excess reserves does First National now hold? a. Assume that all other banks hold only the required amount of reserves. If First National decides to reduce its reserves to only the required amount, by how much would the economy's money supply increase? b.

Explanation / Answer

a) The total deposits become after purchase of security by FED = $450000

reserve requirement ratio = 10%

so minimum reserves = 450000 * 10/100 = 45000

excess reserves = total deposits - minimum reserves

excess reserves = 450000-45000 = 405000

so the excess reserves are $405000

b) Money supply increases = total deposits * money multiplier.

money multiplier = 1/RRR = 1/0.1 = 10

money supply increases = 450000 * 10 = $4500000

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