Assume a 5% desired reserve ratio, zero excess reserves, no currency leakage, a

Question

Assume a 5% desired reserve ratio, zero excess reserves, no currency leakage, a demand. The Bank of Canada purchases a $250,000 worth of Cana from a bond dealer who deposits the proceeds of the sale in Bank sheets to show the immediate effects of this transaction on the Ban (Be sure to label each transaction as either securities, reserves nd a ready loan dian government securities 1. Use the following balance k of Canada and Bank 1. a) Bank of Canada Bank 1 Liabilities Liabilities Assets If the desired reserve ratio is 5%, immediately following the Bank of Canada's security purchase, what are Bank 1's: b) i. Desired Reserves ii. Excess Reserves ili. What is the maximum increase in the money supply? (Show your calculations.)

Explanation / Answer

(a)

It has been provided that Bank of Canada has purchased the Canadian government securities worth $250,000 from a bond dealer who has deposited the proceeds in Bank 1.

This purchase of securities by Bank of Canada will act as asset for Bank of Canada.

On the other hand, deposit with Bank 1 will increase due to this deposit by bond dealer. Deposits acts as liabilities for a bank.

Following is the Balance sheet of Bank of Canada showing the immediate effect of the stated transaction -

Following is the balance sheet of Bank 1 showing the immediate effect of the stated transaction -

(b)

(i)

Deposit = $250,000

Desired reserve ratio = 5% or 0.05

Desired reserves = Deposit * Desired reserve ratio = $250,000 * 0.05 = $12,500

Bank 1's desired reserves are $12,500.

(ii)

Desired reserves = $12,500

Deposit = $250,000

Excess reserves = Deposit - Desired reserves = $250,000 - $12,500 = $237,500

Bank 1's excess reserves are $237,500.

(iii)

Desired reserve ratio = 5% or 0.05

Calculate money multiplier -

Money multiplier = 1/Desired reserve ratio = 1/0.05 = 20

Excess reserves = $237,500

Calculate the maximum increase in the money supply -

Maximum increase in money supply = Excess reserves * Money multiplier

Maximum increase in money supply = $237,500 * 20 = $4,750,000

The maximum increase in money supply is $4,750,000.

Assets Amount Liabilities Amount Securities $250,000

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