The isolated nation of Islandia currently does not trade with other countries. T

Question

The isolated nation of Islandia currently does not trade with other countries. The banking system of Islandia consists of four commercial banks—these banks deal with consumers and businesses—and one central bank that deals exclusively with the commercial banks. The central bank has set a reserve requirement of 10 percent. The banks are creatively named First Bank, Second Bank, Third Bank, and Fourth Bank. All of the commercial banks, except First Bank, have used all of their excess reserves to issue loans to consumers and businesses. First Bank is holding $288,000 in excess reserves.

Suppose First Bank loans all of its excess reserves to a customer to buy a custom-built house. The home builder deposits all of the money received for building the house into Second Bank, which then lends all its excess reserves to a customer to buy machines for her factory. The machine manufacturer deposits all of the money received into Third Bank, which lends all its excess reserves to a clothing maker to buy textiles. The textile manufacturer deposits all of the money received into Fourth Bank, which lends all its excess reserves to a rancher to buy more cattle. By how much have these rounds of lending increased the money supply in Islandia?

Instructions: Round your answer to 2 decimal places.

$

Explanation / Answer

Money created by first bank = 288000 ( when it loans to the customer & deposited in second bank)

Money created by second bank = 288000*(1-10%) = $259200 (when it loans to the customer & deposited in third bank)

Money created by third bank = 259200*(1-10%) = $233280 (when it loans to the customer & deposited in fourth bank)

Money created by fourth bank = 233280*(1-10%) = $209952 ( when it loans to buy the cattle)

So,

Increase in money supply = 288000 + 259200 + 233280 + 209952

Increase in money supply = $990432

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