Homework Unit-11 ( Big Bucks Bank)

U.S. president and confirmed by the Senate. coordinates policies for the 12 Federal Reserve Banks. the Board of Governors members and 5 of the 12 presidents of the Federal Reserve Banks, of which, the president of the New York Fed has a permanent voting seat. votes on the Fed's monetary policy and directs the purchase or sale of government securities.

the policies are coordinated by the Federal Reserve Board of Governors. they are a blend of private ownership and public control. they perform the same functions for banks as banks perform for the public. Issuing Federal Reserve Notes, providing for check collection, and supervising the operation of banks

this independence allows the Fed to more effectively control the money supply and maintain price stability.

owned by the bank, whereas a liability is something owed by the bank.

assets minus liabilities.

assets must equal the sum of liabilities plus net worth.

banks hold a fraction of deposits on reserve. guarantees that depositors will always get their money, avoiding bank runs.

correct because lending increases the money supply, and the repayment reduces checkable deposits, lowering the money supply.

borrowing funds from other banks in the Federal funds market. reduce the amount of loans outstanding.

1 / reserve ratio

increase, the amount of excess reserves in the banking system to rise, and the money supply to increase.

By definition (balance-sheet approach) the total amount of assets must equal liabilities plus net worth. Assets = liabilities + net worth. We can extend this logic to changes. That is, the change in assets must equal the change in liabilities plus the change in net worth. Δ Assets = Δ liabilities + Δ net worth. Substituting the values above, we have $250,000 = Δ liabilities + $40,000. This implies that Δ liabilities = $210,000, which is obviously an increase in liabilities. increased $210,000.

The first step is to calculate the required reserves for the bank. This equals the product of the required reserve ratio (decimal form) and checkable deposits. Required reserves = 0.20 × $150,000 = $30,000. The second step is to calculate actual reserves. This is the sum of required reserves and excess reserves. Actual reserves = required reserves + excess reserves = $30,000 + $8,000 = $38,000. $38,000.

The first step is to calculate checkable deposits. This equals the original checkable deposits plus the new deposit, or $105,000 (= $100,000 + $5,000). The second step is to calculate required reserves for the deposits. This equals the product of the required reserve ratio (decimal form) and checkable deposits. Required reserves = 0.10 × $105,000 = $10,500. The third step is to calculate excess reserves. This equals actual reserves minus required reserves. Since the $5,000 deposit was added to the original reserves of $10,000, the new (actual) reserves equal $15,000. Excess reserves = actual reserves - required reserves = $15,000 - $10,500 = $4,500. $4,500.

The $10,000 sale of securities is directly transferred into the reserves of the bank. This increases reserves by $10,000 to $20,000, but since this was a sale of securities there is no change in checkable deposits immediately following the transaction. The fact that checkable deposits have not changed implies that required reserves have not changed, so required reserves still equal $10,000. Thus, excess reserves equal $10,000 (= actual reserves - required reserves = $20,000 - $10,000). $10,000.

a. The first step is to calculate required reserves. This equals the product of the required reserve ratio (decimal form) and checkable deposits. Required reserves = 0.20 × $100,000 = $20,000. The second step is to calculate excess reserves. This equals actual reserves minus required reserves. Excess reserves = actual reserves - required reserves = $27,000 - $20,000 = $7,000. This is the maximum amount of new loans that the bank can make. After making a loan of $7,000 (excess reserves), loans will increase by $7,000. There is no change in reserves initially (checks have not been drawn against the loan yet) or securities. Once the bank makes the loan, it will also credit the borrower's account (checkable deposits) equal to the value of the loan. Thus, checkable deposits will increase by $7,000. $7,000. b. The immediate effect is an increase in the money supply by $7,000. Checkable deposits have increased by $7,000. (Note that we have not worked through the monetary multiplier yet, so this is the immediate effect of the transaction.) $7,000. c. After checks are drawn against the loan, checkable deposits will fall by $7,000 (the amount of the loan) and reserves will fall by $7,000 (the amount of the loan) after the checks clear. Assets (1' ) (2' ) Reserves [27,000] [27,000] [20,000] Securities [38,000] [38,000] [38,000] Loans [35,000] [42,000] [42,000] Liabilities and net worth (1' ) (2' ) Checkable deposits [100,000] [107,000] [100,000] d. Answer questions a, b, and c on the assumption that the reserve ratio is 15 percent. For part a, the first step is to calculate required reserves. This equals the product of the required reserve ratio (decimal form) and checkable deposits. Required reserves = 0.15 × $100,000 = $15,000. The second step is to calculate excess reserves. This equals actual reserves minus required reserves. Excess reserves = actual reserves - required reserves = $27,000 - $15,000 = $12,000. This is the maximum amount of new loans that the bank can make. After making a loan of $12,000 (excess reserves), loans will increase by $12,000. There is no change in reserves initially (checks have not been drawn against the loan yet) or securities. Once the bank makes the loan it will also credit the borrower's account (checkable deposits) equal to the value of the loan. Thus, checkable deposits will increase by $12,000. $12,000 For part b, the immediate effect is an increase in the money supply by $12,000. Checkable deposits have increased by $12,000. (Note that we have not worked through the monetary multiplier yet, so this is the immediate effect of the transaction.) For part c, after checks are drawn against the loan, checkable deposits will fall by $12,000 (the amount of the loan) and reserves will fall by $12,000 (the amount of the loan) after the checks clear. $12,000 Assets (1' ) (2' ) Reserves [27,000] [27,000] [15,000] Securities [38,000] [38,000] [38,000] Loans [35,000] [47,000] [47,000] Liabilities and net worth (1' ) (2' ) Checkable deposits [100,000] [112,000] [100,000]

a. The monetary multiplier equals one divided by the required reserve ratio. Monetary multiplier = 1/required reserve ratio = 1/0.10 = 10. 10. b. We can rearrange this question to solve for the required reserve ratio when given the monetary multiplier. Required reserve ratio = 1/monetary multiplier = 1/4 = 0.25, or 25 percent. 25

a. The first step is to calculate required reserves. This equals the product of the required reserve ratio (decimal form) and checkable deposits. Required reserves = 0.25 × $200 billion = $50 billion. The second step is to calculate excess reserves. This equals actual reserves minus required reserves. Excess reserves = actual reserves - required reserves = $56 billion - $50 billion = $6 billion. The third step is to calculate the maximum amount the banking system (not a single bank) might lend. This is found by taking the product of the monetary multiplier and the amount of excess reserves. Monetary multiplier = 1/required reserve ratio = 1/0.25 = 4. Maximum amount of loans = 4 × $6 billion = $24 billion. 6 24 4 16 80 5 56 Assets 1 (a) Reserves [56][56] Securities [44][44] Loans [100][124] Liabilities and net worth 1' (b) Checkable deposits [200][224] Two things to note here: (1) The banking system does not lose reserves and (2) checkable deposits increase by the amount of the loans (money creation through the fractional reserve banking system). b. We follow the same steps but with a required reserve ratio of 20 percent. The first step is to calculate required reserves. This equals the product of the required reserve ratio (decimal form) and checkable deposits. Required reserves = 0.20 × $200 billion = $40 billion. The second step is to calculate excess reserves. This equals actual reserves minus required reserves. Excess reserves = actual reserves - required reserves = $56 billion - $40 billion = $16 billion. The third step is to calculate the maximum amount the banking system (not a single bank as in problem 5) might lend. This is found by taking the product of the monetary multiplier and the amount of excess reserves. Monetary multiplier = 1/required reserve ratio = 1/0.20 = 5. Maximum amount of loans = 5 × $16 billion = $80 billion. Assets 1 (a) Reserves [56][56] Securities [44][44] Loans [100][180] Liabilities and net worth 1' (b) Checkable deposits [200][280] With the required reserve ratio of 20 percent (rather than 25 percent), the banking system can lend $56 billion more (= $80 billion - $24 billion).

assist the economy in achieving a full-employment, non-inflationary level of total output.

monetary policy has a much shorter administrative lag than fiscal policy.

its speed and flexibility.

rises to 4.5% which occurs when there are fewer funds available.

increased.

increasing the reserve ratio or discount rate or selling bonds.

reduce the lending ability of the banking system, increase the real interest rate, and reduce investment spending, aggregate demand, and inflation.

fall, investment spending will rise, aggregate demand will shift right, and real GDP and the price level will rise.

a. The equilibrium interest rate occurs at the interest rate where the quantity of money supplied equals the quantity of money demanded. Thus, the equilibrium interest rate is 5 percent. 5 b. Investment at this interest rate is $30. 30 c. At the interest rate of 5 percent, potential GDP is $350 and actual GDP is $330. Since actual GDP is less than potential GDP, there is a recessionary (negative) GDP gap. The gap is the difference, so the amount of the recessionary gap is $20. 20 d. To eliminate the recessionary gap, that is to move actual GDP to $350 so that it equals potential GDP, the central bank will need to increase the money supply to $600. When the money supply is $600, the equilibrium interest rate is now 4 percent and investment is $40. 100 e. To find the (expenditure) multiplier, we can divide the change in actual GDP by the change in investment. Multiplier = ($350 - $330)/($30 - $20) = $20/$10 = 2. 2