The money supply expansion process Suppose First Main Street Bank, Second Republ

Question

The money supply expansion process Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank all have zero excess reserves. The required reserve ratio is 5%. The Federal Reserve buys a government bond worth $200,000 from Charles, a client of First Main Street Bank. He deposits the money into his checking account at First Main Street Bank. On the Assets side of First Main Street Bank's balance sheet (before the bank makes any new loans), this First Main Street Bank's by. On the Liabilities and Net Worth side of First Main Street Bank's balance sheet, this First main Street Bank's by. Now, suppose First Main Street Bank loans out all of its new excess reserves to Alyssa, who immediately uses the funds to write a check to Jeff. Jeff deposits the funds immediately into his checking account at Second Republic Bank. Then Second Republic Bank lends out all of its new excess reserves to Stelios, who writes a check to Laura, who deposits the money into her account at Third Fidelity Bank. Third Fidelity lends out all of its new excess reserves as well. Fill in the following table to show the effect of this ongoing chain of events at each of the banks. Enter each answer to the nearest penny. Assume this process continues, with each successive loan deposited into a checking account and no banks keeping any excess reserves. Under these assumptions, the $200,000 injection into the money supply allows banks to make in new loans, resulting In an overall increase of in checkable deposits.

Explanation / Answer

(a) On asset side, this increases the Reserves by $200,000 and on liabilities side, this increases Checkable deposits by $200,000.

(b) Increase in required reserve = Increase in deposit x Required reserve ratio (5%)

Increase in loans = Increase in deposit - Increase in required reserve

c)

Increase: Deposit

Increase: Required reserve

Increase: Loan

First bank

$200,000

$10,000

$190,000

Second bank

$190,000

$9,500

$180,500

Third bank

$180,500

$9,025

$171,475

(d) This allows banks to make [($200,000 / 0.05) x 0.95] = $3,800,000 in new loans, and an overall increase of ($200,000 / 0.05) = $4,000,000 in checkable deposits.

Increase: Deposit

Increase: Required reserve

Increase: Loan

First bank

$200,000

$10,000

$190,000

Second bank

$190,000

$9,500

$180,500

Third bank

$180,500

$9,025

$171,475

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