Suppose that a small town banking system has the following balance sheet: Liabil

Question

Suppose that a small town banking system has the following balance sheet:

Liabilities: Deposits $100
Assets: Reserves $10, loans $100, bonds $40
Net worth: $50

reserve ratio: 5%

a. what is the level of required reserves and excess reserves held by banks in this town?
b. what is the money supply in this town? what would the money supply be in the town if the banks held zero excess reserves?
c. suppose that the bank injects $1 into the banking system via open market operations. what is the banking system's balance sheet immediately after open market operations have been completed?
d. what is the money supply after banks respond to the injection of reserves in c by altering the amount of lending they do?

any help is greatly appreciated!

Explanation / Answer

a) Required reserve = 5 % of $100 = $ 5 Excess reserve held = $ (10 - 5) = $ 5 b) Money supply in the town = loans + bonds = $ (100+40) = $ 140 If reserve is reduced to required level of $5, money supply will increase by $5 i.e. to $ (140 +5) = $145 level c) If $ 1 is injected in the system, balance sheet will be : Liabilities: Deposits $100 Assets: Reserves $9, loans $101, bonds $40 Net worth: $50 d) Lending amount will be $101 and money supply will be $141 (loan +bonds)

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