A bank currently has $700,000 in deposits, of which $60,000 is in cash in the va
ID: 1225528 • Letter: A
Question
A bank currently has $700,000 in deposits, of which $60,000 is in cash in the vault, $120,000 is on deposit with the Fed, $70,000 is held in government securities, and the rest has been loaned out. The required reserve ratio is 20 percent. Answer these questions:
1) If the bank has excess reserves, what is the maximum amount the money supply can increase when they are loaned out (also assuming this bank is the only bank in the system that has excess reserves)? For questions 2-5, assume the bank is operating with no currently existing excess reserves.
2) An individual deposits a $750,000 check into the bank. That individual had just converted foreign currency into dollars so the $750,000 was not in the money supply before the deposit. What is the maximum size loan the bank can make once the check clears?
3) What is the maximum amount the money supply can increase as a result of the $750,000 deposit?
4) If these expansions in the money supply happen, what effect will it have on aggregate demand, GDP, and employment?
5) What could keep the expansions from happening? Work with your group members to answer these questions.
Explanation / Answer
Question 1
Total deposits with bank = $700,000
Required reserve ratio = 20% or 0.20
Required reserves = Total deposit * required reserve ratio
= $700,000 * 0.20
= $140,000
Total reserves = Cash in vault + Deposit with Fed
= $60,000 + $120,000
= $180,000
Excess reserves = Total reserves – Required reserves
= $180,000 - $140,000
= $40,000
Money multiplier = 1/Required reserve ratio
= 1/0.20
= 5
If bank loaned out all its excess reserves then,
Maximum increase in money supply = Excess reserves * Money multiplier
= $40,000 * 5
= $200,000
The maximum amount of increase in money supply is $200,000.
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