Apia: Student Question C 5. The Money Sa AllermptS Average: 5. The money supply

Question

Apia: Student Question C 5. The Money Sa AllermptS Average: 5. The money supply contraction process Suppoce First Main Street Bank, Second Republic Bank, and Third Fidelity Bank all have zero excess reserves the required reserve ratio is % usash, a crvent of First Main Street Bank, purchases S200,000 of Treasury bills in an open market sale undertaken by the Fed. Upon recapt of Musashi's check, the Fad subtracts s200,000 from First hain Streot Bank 's Federal Reserve account, theraby extinguishing the money. the tt Comoute the folbwvy t rebie to refiect any cherges in Arst Main Street Bank's bevance sheet(botere the bank makes any es angl. First Main Stroet lank's Balance Sheet

Explanation / Answer

(A) Completed table as follows.

First Main Street Bank's Balance Sheet

Assets

Liabilities

Reserves   

- $200,000

Checkable Deposits

- $200,000

(B)

The $200,000 withdrawal decreases required reserves by $10,000 (= $200,000 x 5%). In order to maintain required reserves ratio, First Bank must decrease its reserves by $190,000 (= $200,000 - $10,000). One way to do this is to increase outstanding loans (by $10,000 such that Decrease in Reserves = Increase in Loans).

(C)

Bank

Decrease in Checkable Deposits

Decrease in Required Reserves

Decrease in Loans

(Dollars)

(Dollars)

(Dollars)

First Main Street Bank

200,000

10,000

190,000

Second Republic Bank

190,000

9,500

180,500

Third Fidelity Bank

180,500

9,025

171,475

(D)

Initial destruction of $200,000 results in overall decrease of $4,000,000 (= $200,000 / 0.05).

First Main Street Bank's Balance Sheet

Assets

Liabilities

Reserves   

- $200,000

Checkable Deposits

- $200,000

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