(a) If banks operate a 20 per cent liquidity ratio, by how much will credit expa
ID: 1213565 • Letter: #
Question
(a) If banks operate a 20 per cent liquidity ratio, by how much will credit expand if new deposits of £100 million are made by the customers of banks.
(b) Show the combined balance sheet (of additional liabilities and assets) for all banks (i) at the beginning, and (ii) at the end of this process.
(i) Initial effect
(ii) Eventual effect
Liabilities £m Assets £m Initial new deposits ….. Initial additional liquid assets ….. Initial additional credit …. Total Initial new liabilities …. Total initial new assetsExplanation / Answer
(a) If banks operate a 20 per cent liquidity ratio, by how much will credit expand if new deposits of £100 million are made by the customers of banks.
Money Multiplier = 1/0.20 = 5
Total Money Supply in the economy = 100,000,000 * 5 = 500 million
(b) Show the combined balance sheet (of additional liabilities and assets) for all banks (i) at the beginning, and (ii) at the end of this process.
(i) Initial effect
Liabilities £m
In million
Assets £m
In million
Initial new deposits
100
Initial additional liquid assets
20
Initial additional credit
80
Total Initial new liabilities
100
Total initial new assets
100
(ii) Eventual effect
Liabilities £m
In million
Assets £m
In million
Eventual new deposits
500
Eventual additional liquid assets
100
Eventual additional credit
400
Total eventual additional liabilities
500
Total eventual additional assets
500
Liabilities £m
In million
Assets £m
In million
Initial new deposits
100
Initial additional liquid assets
20
Initial additional credit
80
Total Initial new liabilities
100
Total initial new assets
100
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