Answer:
a) Assets: Reserves $200,000; Liabilities: Deposits $200,000
b) Amount Deposited: $2000,000; Change in Excess Reserves: $190,000; and Change in Required Reserves: $10,000
c) See the calculation below and the attached excel file for the table.
d) the $200,000 injection into the money supply results in an overall increase of <u>$4,000,000 </u>in demand deposits.
Explanation:
These can be answered as follows:
a) Complete the following table to reflect any changes in First Main Street Bank's T-account (before the bank makes any new loans).
Note: See the attached excel file for the table.
The $200,000 deposited by Lorenzo to First Main Street Bank led to the creation of both an asset and a liability for First Main Street Bank.
As a result, the reserve of the bank is increased by $200,000 on the asset side of the T-account. It is therefore now possible for the ban to grant loan to other customers from these additional reserves.
In addition, the demand deposit of the bank is increased by $200,000 on the liability side of the T-account. This is recorded as a demand deposit because it is possible for Lorenzo to come at any time to the band to withdraw his deposit either by using a debit card or by writing a check.
b) Complete the following table to show the effect of a new deposit on excess and required reserves when the required reserve ratio is 5%. Hint: If the change is negative, be sure to enter the value as negative number.
Note: See the attached excel file for the table. Just scroll the excel file down to part b.
The required reserve ratio of 5% indicates that First Main Street Bank has to hold 5% of the $200,000 the deposit or fresh fresh reserves, and this will result in having a 95% excess reserve which the bank can employ to grant loans.
From the amount deposited, the change in excess reserve and the change in the required reserve can be computed as follows:
Amount deposited = $200,000
Change in excess reserve = $200,000 * (1 - 5%) = $190,000
Change in required reserve = $200,000 * 5% = $10,000
c) Now, suppose First Main Street Bank loans out all of its new excess reserves to Juanita, who immediately uses the funds to write a check to Gilberto. Gilberto deposits the funds immediately into his checking account at Second Republic Bank. Then Second Republic Bank lends out all of its new excess reserves to Lorenzo, who writes a check to Neha, who deposits the money into her account at Third Fidelity Bank. Third Fidelity lends out all of its new excess reserves to Teresa as well.Fill in the following table to show the effect of this ongoing chain of events at each bank. Enter each answer to the nearest dollar.
Note: See the attached excel file for the table. Just scroll the excel file down to part c.
As already computed in part b above, we have the following to show the effect of this ongoing chain of events at each bank, we have:
<u>For First Main Street Bank:</u>
Increase deposit = Deposit from Lorenzo = $200,000
increase in required reserve = $200,000 * 5% = $10,000
Increase in loans = Loan to Juanita = $200,000 * (1 - 5%) = $190,000
<u>For Second Republic Bank:</u>
Increase deposit = Deposit from Gilberto = $190,000
Increase in required reserve = $190,000 * 5% = $9,500
Increase in Loans = Loans to Lorenzo = $190,000 * (1 - 5%) = $180,500
<u>For Third Fidelity Bank:</u>
Increase deposit = Deposit from Neha = $180,500
Increase in required reserve = $180,500 * 5% = $9,025
Increase in Loans = Loans to Teresa = $180,500 * (1 - 5%) = $171,475
d) Assume this process continues, with each successive loan deposited into a checking account and no banks keeping any excess reserves. Under these assumptions, the $200,000 injection into the money supply results in an overall increase of in demand deposits.
In order to calculate this, the formula for the money multiplier is used to multiply the initial deposit or injection of $200,000 by Lorenzo as follows:
Money multiplier = 1/r
Where r denotes required reserve ratio of 5%, or 0.05.
Therefore, we have:
Overall increase in demand deposits = Injection * (1 / r) = $200,000 * (1 / 0.05) = $200,000 * 20 = $4,000,000
Therefore, the $200,000 injection into the money supply results in an overall increase of <u>$4,000,000 </u>in demand deposits.
