(a.) Third National Bank is fully loaned up with reserves of $30,000 and demand
ID: 1230755 • Letter: #
Question
(a.) Third National Bank is fully loaned up with reserves of $30,000 and demand deposits equal to $100,000. The reserve ratio is 5%. Households deposit $20,000 in currency into the bank. How much excess reserves does the bank now have, and what is the maximum amount of new money that can be created in the banking system as a result of this deposit? Show all work.(b.) What is the fed funds rate in the banking system? Explain how the Fed manipulates this rate in order to achieve macroeconomic objectives.
Explanation / Answer
(a.) ANS. The banks have $4,000 in excess reserves because households deposit $5,000 and the bank is required to hold 20%, or $1,000 in the way of required reserves. The difference between total reserves (in this case, $5,000) and required reserves (in this case, $1,000) equals excess reserves (in this case, $5,000 - $1,000 = $4,000). Max. New Money = (Excess Reserves)(1/r) where r is the required reserve ratio. Thus, Max. New Money = $4,000 / 0.2 = $4,000 x 5 = $20,000. (b.) ANS. The discount rate is, effectively, the interest rate that is charged on loans made by the Fed to its member banks. If the Fed wants to stimulate the economy, it will lower the discount rate to encourage borrowing by the banks and, hence, by the public, and, if the Fed wishes to slow down the economy for any reason, it will increase the discount rate.
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