Question

Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank all have zero excess reserves. The required reserve ratio is 25%. The Federal Reserve buys a government bond worth $1,800,000 from Yakov, a client of First Main Street Bank. He deposits the money into his checking account at First Main Street Bank.
Complete the following table to reflect any changes in First Main Street Bank's T-account (before the bank makes any new loans)

Assets Liabilities

Complete the following table to show the effect of a new deposit on excess and required reserves when the required reserve ratio is 25%.

Amount Deposited (Dollars) Change in Excess Reserves (Dollars) Change in Required Reserves (Dollars)
1,800,000

Answer 1

Answer:

a) First Main Street Bank's T-account (before the bank makes any new loans) will look as follows:

                  Assets                         |                Liabilities                  

Reserves                   $1,800,000 |  Deposits             $1,800,000

b) The effect of a new deposit on excess and required reserves when the required reserve ratio is 25% are as follows:

Amount Deposited (Dollars) = $1,800,000

Change in Excess Reserves (Dollars) = $1,350,000

Change in Required Reserves (Dollars) = $450,000

Explanation:

a) Complete the following table to reflect any changes in First Main Street Bank's T-account (before the bank makes any new loans)

A deposit of $1,800,000 by Yakov into his checking account at First Main Street Bank will lead to the creation of both an asset and a liability for First Main Street Bank.

The reserves on the asset side of the T-account of First Main Street Bank will therefore increase by $1,800,000. This gives the bank the opportunity to able to give loan to its other customers from the additional reserves.

On the other hand, the deposit of $1,800,000 by Yakov will be recorded as a demand deposit on the liability side of the T-account of First Main Street Bank. This is because it is possible for Yakov to withdraw his deposit at any time.

This transaction will therefore be reflected as follows:

                  Assets                         |                Liabilities                  

Reserves                   $1,800,000 |  Deposits             $1,800,000

b) Complete the following table to show the effect of a new deposit on excess and required reserves when the required reserve ratio is 25%.

Note: See the attached excel file to see how the table will actually look.

The required reserve ratio of 25% implies that First Main Street Bank is required by law to hold 25% of the new reserves which in this case is the initial deposits from Yakov.

By calculating this, 25% of $1,800,00 is $450,000 and it indicates an increase of $450,000 in the required reserve of First Main Street Bank.

After deducting 25% from 100%, we have 75% left. And 75% of $1,800,000 is $1,350,000. This $1,350,000 is the excess reserves that First Main Street Bank can use to give loans to other customers.

The breakdown is therefore as follows:

Amount Deposited (Dollars) = $1,800,000

Change in Excess Reserves (Dollars) = 75% * $1,800,000 = $1,350,000

Change in Required Reserves (Dollars) = 25% * $1,800,000 = $450,000

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