Suppose Bank A, which faces a reserve requirement of 10 percent, receives a $1,0

Question

Suppose Bank A, which faces a reserve requirement of 10 percent, receives a $1,000 deposit from a customer.

a.Assuming that it wishes to hold no excess reserves, determine how much the bank should lend. Show your answer on A’s balance sheet.
b.Assuming that the loan shown in Bank A’s balance sheet is redeposited in Bank B, show the changes in Bank B’s balance sheet if it lends out the maximum possible.
c.Repeat this process for three additional banks: C, D, and E.
d.Using the simple money multiplier, calculate the total change in the money supply resulting from the $1,000 initial deposit.
e.Assume Banks A, B, C, D and E each wish to hold 5 percent excess reserves. How would holding this level of excess resrves affect the total change in the money supply.

Explanation / Answer

a.) 10% of $1,000 is $100, so it will loan out the remaining $900. Reserves = $100 Loans Receivable = $900 Deposits owed = $1000 b.) 10% of $900 is $90, so it will loan out the remaining $810. Reserves = $90 Loans Receivable = $810 Deposited owed = $900 c.) 10% of $810 is $81, so it will loan out the remaining $729. Reserves = $81 Loans Receivable = $729 Deposited owed = $810 10% of $729 is $72.90, so it will loan out the remaining $656.10. Reserves = $72.90 Loans Receivable = $656.10 Deposited owed = $729 10% of $656.10 is $65.61, so it will loan out the remaining $590.49. Reserves = $65.61 Loans Receivable = $590.49 Deposited owed = $656.10 d.) If repeated ad infinitum, the total change to the money supply would be $10,000. = $1,000 * inverse of reserve requirement = $1,000/(1/10) e.) Like in part d, it would increase the money supply, but instead of ten-fold, it would be by twenty-fold, so $20,000 net change.

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