A bank currently has $700,000 in deposits, of which $60,000 is in cash in the va
ID: 2742056 • Letter: A
Question
A bank currently has $700,000 in deposits, of which $60,000 is in cash in the vault, $120,000 is on deposit with the Fed, $70,000 is held in government securities, and the rest has been loaned out. The required reserve ratio is 20 percent. Answer these questions: 1) If the bank has excess reserves, what is the maximum amount the money supply can increase when they are loaned out (also assuming this bank is the only bank in the system that has excess reserves)? For questions 2-5, assume the bank is operating with no currently existing excess reserves. 2) An individual deposits a $750,000 check into the bank. That individual had just converted foreign currency into dollars so the $750,000 was not in the money supply before the deposit. What is the maximum size loan the bank can make once the check clears? 3) What is the maximum amount the money supply can increase as a result of the $750,000 deposit? 4) If these expansions in the money supply happen, what effect will it have on aggregate demand, GDP, and employment? 5) What could keep the expansions from happening?
Explanation / Answer
A bank currently has $700,000 in deposits, of which $60,000 is in cash in the vault, $120,000 is on deposit with the Fed, $70,000 is held in government securities, and the rest has been loaned out. The required reserve ratio is 20 percent. Answer these questions: 1) If the bank has excess reserves, what is the maximum amount the money supply can increase when they are loaned out (also assuming this bank is the only bank in the system that has excess reserves)?
The required reserve ratio is 20 percent and bank deposit are $700,000
Therefore required reserve is $700,000 *20% = $140,000
The reserves of a commercial bank consist of deposits at the Federal Reserve Bank and vault cash that is = $60,000+$120,000 = $180,000
The excess reserve held by bank = $ 180,000 - $ 140,000 =$40,000
The maximum amount the money supply can increase when they are loaned out
= (1/ Reserve requirement) * excess reserve
= (1/0.20) * $40,000 = $200,000
For questions 2-5, assume the bank is operating with no currently existing excess reserves.
2) An individual deposits a $750,000 check into the bank. That individual had just converted foreign currency into dollars so the $750,000 was not in the money supply before the deposit. What is the maximum size loan the bank can make once the check clears?
the maximum size loan the bank can make once the check clears is the excess amount over the reserve requirement
Reserve requirement = $750,000 * 20% = $150,000
Excess reserve for loan = $750,000 - $150,000 = $600,000
3) What is the maximum amount the money supply can increase as a result of the $750,000 deposit?
The maximum amount the money supply can increase
= (1/ Reserve requirement) * excess reserve
= (1/0.20) * $600,000 = $3,000,000
4) If these expansions in the money supply happen, what effect will it have on aggregate demand, GDP, and employment?
The increase in the money supply will increase the nominal output or Gross Domestic Product (GDP) in equal amount.
The increase in the money supply will lead to an increase in consumer spending. This increase will shift the aggregate demand curve to the right.
The increase in money supply will lead to higher prices and more potential real output and will increase employment.
5) What could keep the expansions from happening?
By increasing the reserve requirement ratios, one can reduces the volume of deposits that can be supported by a given level of reserves and in the absence of other measures it will reduce the money supply in the economy and reduce the consumer spending and it will also increase the cost of credit.
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