Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank al

Question

Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank all have zero excess reserves. The ured reserve ratio is 5%. Clancy, a client of First Main Treasury bills from the Fed. The Fed then destroys the $100,000 suddenly withdraws $100,000 and purchases On the assets side of First Main Street Bank's balance sheet (before the bank makes any new loans), this decreases First Main Street Bank's of First Main Street Bank's balance sheet, this decreases by $100,000 .On the liabilities side checking account deposits by $100,000 First Main Street Banks Because the required reserve ratio is 5%, the $100,000 withdrawal required reserves by$5,000 must increase its reserves by $95,000One possible way to do this is to decrease its In order to maintain the required reserve ratio, First Main Street Bank now decreases First Main Street Bank's Now suppose Madeline repays her loan of $95,000 to First Main Street Bank by writing a check issued by Second Republic Bank. First Main Street Bank uses funds new loans. Second Republic Bank then replenishes its writes a check issued by Third Fidelity Bank. Third Fidelity Bank then uses a loan repayment from its reserves instead of making new loans from a loan repayment to increase its reserves instead of making reserves by using the funds from loan repayments by Jim, who Kathy to replenish Fill in the folowing table to show the effect of this ongoing chain of events at each of the withdrawal at the beginning of the question. Enter each answer to the nearest penny banks, including the instial Decrease in Checking Account Deposits Decrease in Loans $95,000.00 $90,250.00 Bank Required Reserves Second Republic Bank $95,000.00 $90,250.00 Assume this process continues, with each successive loan being repaid using a checking account and banks using repayments to replenish their reserves without issuing any new loans. Under these assumptions, the initial destruction of $100,000 by the Fed caused banks to reduce their outstanding loans by in an overall decrease of , resulting in checking account deposits.

Explanation / Answer

Required reserve ratio = 5%

Clancy, a client of first main street bank , suddenly withdraws $ 100,000 and purchases treasury bills from the fed. The fed then destroys the $100,000

On the assets side of the first main street bank's balance sheet ,this decreases First main street bank's reserves by $100,000 . On the liabilities side of first main street bank's balance sheet ,this decreases First main street bank's checkable deposits by $100,000.

Because the required reserve ratio is 5%, the withdrawal decreases First main street bank's required reserves by $(100,000)(5%) = $5,000. In order to maintain the required reserve ratio , First main street bank now must increase its reserves by $(100,000 - 5,000)= $95,000. One possible way to do this is to decrease its outstanding loan.

$ (95,000)(5%)=$ 4750

Assume this process continues,with each successive loan being repaid using a checking account and banks using repayments to replenish their reserves without issuing any new loans. Under these assumptions,the initial destruction of $100,000 by the fed caused banks to reduce their outstanding loans by (20,00,000 - 100,000) =$19,00,000, resulting in an overall decrease of $(100,000)(100)/5 = $20,00,000 in checking account deposits.

Bank Decrease in checking account deposits Decrease in required reserves Decrease in Loans First Main street bank $ 100,000 $ 5,000 $ 95,000 Second republic bank $ 95,000

$ (95,000)(5%)=$ 4750

$(95,000 - 4750)= $90,250 Third fidelity bank $ 90,250 $(90,250)(5%) = $ 4512.5 $(90,250 -4512.5)= $ 85,737.5

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