Do No Harm: 15 Aa Aa E. 4. The money creation process Suppose First Main Street

Question

Do No Harm: 15 Aa Aa E. 4. The money creation process Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank a have zero excess reserves. The required reserve-deposit ratio is 5%. David, a client of First Main Street Bank, suddenly receives $100,000 from a long-forgotten relative. He deposits the money in his checking account at First Main Street Bank. Because the required reserve-deposit ratio is 5%, the $100,000 deposit First Main Street Bank's required reserves by First Main Street Bank's excess reserves by and, therefore, increases decreases Now suppose First Main Street Bank loans out all of its new excess reserves to Crystal, who immediately uses the funds to write a check to Darnell, Darnell 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 Rajiv, who writes a check to Kate, who deposits the money in her account at Third Fidelity Bank. Third Fidelity lends out all its excess reserves as well Fill in the following table to show the effect of this ongoing chain of events at each of the banks. Enter each answer to the nearest penny. Increase in Increase in Increase in Bank Demand Deposits Required Reserves Loans First Main Street Bank Second Republic Bank Third Fidelity Bank Assume this process continues, with each successive loan being deposited in a checking account and no banks keeping any excess reserves. Under these assumptions, the $100,000 injection into the banking system allows banks to make in new loans, resulting in an overall increase of in demand deposits. Grade It Now Save & Continue QNA 3.16 2004-2016 Aplia. All rights reserved 2013 Cengage Learning except as noted. All rights reserved

Explanation / Answer

$100,000 increase in deposits will increase bank's Required reserves by .05 * 100,000 = $5,000 and excess reserves will increase by $100,000 - $5,000 = $95,000.

Deposits Required Reserves loans

I bank 100,000 5,000 95,000

II bank 95,000 4750 90250

III bank 90250 4512.5 85,737.5

Increases

Overall increase in demand deposits = 1 / RRR * 100,000 = 1 / .05 * 100,000 = 2,000,000

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