The following are simplified consolidated balance sheets for the commercial bank

Question

The following are simplified consolidated balance sheets for the commercial banking system and the Federal Reserve Banks. All figures are in billions of dollars, FRBs = Federal Reserve Banks, and CBs = Commercial Banks. R = 20%. Assume all Commercial Bank Reserves are kept on deposit in the Federal Reserve Banks.

a. The money multiplier is ______. 1 point

b. Perform the following transaction, making appropriate changes in column (1) of each balance sheet: The Fed buys $10 billion in securities from commercial banks. For your response, write CB: and put the five numbers (going down the column) separated by commas, then FRBs: and put those five numbers separated by commas. 5 points

c. The change in commercial bank reserves as a result of the transaction is $______ billion and the change in the money-creating potential of the banking system is $______ billion. 2 points

d. This Fed action represents ____________ (contractionary / expansionary) monetary policy meant to ________ (lower / raise) market interest rates and __________ (increase / decrease) aggregate demand to eliminate a(n) _____________ (recessionary / inflationary) gap. For each blank, choose the correct term from those in parentheses following the blank.

Banking System (0) (1)       Federal Reserve Banks (0) (1) Assets: Assets:      Reserves 155   $______ Securities    542   $______      Securities 141     ______ Loans to CBs 25     ______      Loans 329     ______ Liabilities:     Liabilities:    Reserves of CBs 155   ______      Checkable Deposits   600   ______ Treasury Deposits 30     ______      Loans from FRBs 25   ______ Federal Reserve Notes 382   ______

Explanation / Answer

a. Money multiplier = 1/R ; reciprocal of the reserve ratio.

Given R= 20%,

the money multiplier = 1/20% = 100/20 = 5.

b. CB: 165, 141, 329, 610, 25

FRBs: 552, 25, 165, 30, 382

Purchase of the securities worth $10 billion by the Fed increases the reserves with the commercial banks from $155 billion to $165 billion under assets and also increases the Checkable Deposits to $610 (as total assets and total liabilities always have to be equal).

Following this purchase, the Fed's securities increase by $10 billion (from $542 billion to $552 billion). There is a corresponding increase in Reserves of CBs under the Fed's liabilities from $155 billion to $165 billion.

c. The change in the commercial bank reserves = $10 billion (the amount of the securities worth purchased by the Fed)

Change in the money-creating potential of the banking system= 5 * (.8) * 10 = 40 (using the money multplier multiplied by the excess reserve created by the Fed's purchase.

d. expansionary; lower; increase; recessionary

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