Suppose the banks in the Federal Reserve System have $10 billion in transactions

Question

Suppose the banks in the Federal Reserve System have $10 billion in transactions accounts, the minimum reserve ratio is 0.12, and there are no excess reserves in the system. If the minimum reserve ratio changes to 0.10, then the unused lending capacity becomes:

$2 billion.

$1.2 billion.

$12 billion.

$200 million.

hen the Fed raises the discount rate, this policy initiative:

Raises the cost of borrowing reserves to member banks.

Is a signal that the Fed is moving toward a slower growth rate for the money supply.

Is a signal that the Fed is reluctant to lend reserves.

All of the above.

$2 billion.

$1.2 billion.

$12 billion.

$200 million.

Explanation / Answer

(1) Option (4)

Initial Required reserves ($ Billion) = 10 x 0.12 = 1.2

New Required reserves ($ Billion) = 10 x 0.1 = 1

Unused lending capacity = Decrease in required reserves = $(1.2 - 1) billion = $0.2 billion = $200 million

(2) Option (4)

Discount rate is the interest rate charged by Fed when member banks borrow from Fed. So an increase in discount rate signals a tighter monetary policy of reducing growth in money supply, since banks' cost of borrowing increases.

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