/assume that the Bank of Ecoville has the following balance sheet of Fedhas 10%

Question

/assume that the Bank of Ecoville has the following balance sheet of Fedhas 10% reserve requir.This is the Sheet for Ecoville International Bank. Assets cash is 33,000. Assets loans is 66,000. Liabilities demand deposits is 99,000. Assume that Fed lowers the reserve requirement to 8%. What is the maximum amount of loans that this bank can make?Assume that the bank makes these loans. What will the new balance sheet look like? By how much has the money supply increased and decreased? Explain answers.

Explanation / Answer

With a 10% reserve ratio and $99K in deposits, the bank could havemade loans with $89.1K of cash (leaving the required $9.9K for thereserve). With a reserve ratio of 8%, only $7.92K of the $99K would have tobe retained as cash. Therefore the maximum amount of new loans the bank could make is$33K cash - 7.92K reserve = $25,080 (The bank already had $66,000 in existing loans). Therefore the balance sheet after making the new loans would be Assets: $7,920 cash, $91,080 loans Liabilities: $99,000 demand deposits. In a closed system (where loaned money is paidby the borrower to someone who then deposits it back into the bank,the multiple ends up being 1/reserve ratio. Therefore, whenthe reserve ratio was 10%, the multiple was 10 (i.e.,1/.10). By decreasing the reserve to 8%, the multiple increases to 12.5(i.e., 1/.08) Therefore, the money supply has increased by 25%(from 10 to 12.5), or from $99,000 to $123,750 (i.e. a total of $24,750)

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