You serve as a staff economist for the Board of Governors of theFederal Reserve

Question

You serve as a staff economist for the Board of Governors of theFederal Reserve System and are given the following informationabout the current economic and monetary situation.

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Cash held by the public: $400 million
Discount rate: 5%
Total reserves: $1,000 million
Unemployment rate: 7.6%
Required reserve ratio: 20%
Rate of inflation: 1.1%
Checkable deposits: $5,000 million

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Which of the following statements accurately describes the monetarysituation?



A. Banks are holding excess reserves and can increase loans by $500million.

B. Banks are holding excess reserves and can increase loans by$1,000 million.

C. Banks have no excess reserves and cannot make additionalloans.

D. Banks are not meeting the required reserve ratio and must reduceloans by $300 million.

Explanation / Answer

The question is concerned with the amount of reserves, sothere's a whole lot of extrenous information here. When considering reserves, we only need to know - Total current reserves - Required reserve ratio - Checkable deposits (or demand deposits) What this question asks is if the bank has excess or has notmet the required reserve ratio. The required reserve ratio is the amount of cash the bank mustkeep on hand (ie not loan out) relative to the demand deposits theyhave (ie, M1 money, checking accounts and the like) This is set by the government in the Bank Act. In this situation, the bank must keep 20% (.2) reserveratio. Their demand deposits are $5,000 million Thus their required reserves are $5,000 million * .2 = $1,000million. Compare that to their actual reserves and answer the questionfrom there. (I'm new, is this the proper protocol for "not giving away thefinal answer"?)

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