Bank Three currently has $450 million in transaction deposits on its balance she

Question

Bank Three currently has $450 million in transaction deposits on its balance sheet. The Federal Reserve has currently set the reserve requirement at 8 percent of transaction deposits.

a. If the Federal Reserve decreases the reserve requirement to 6 percent, show the balance sheet of Bank Three and the Federal Reserve System just before and after the full effect of the reserve requirement change. Assume Bank Three withdraws all excess reserves and gives out loans and that borrowers eventually return all of these funds to Bank Three in the form of transaction deposits.
b. Redo part (a) using a 10 percent reserve requirement.

Explanation / Answer

a) Reserves = $450 million x 8% = $36 million

balance sheets before effect of reserve requirement change -

Above are the initial balance sheets.

New reserve requirement = 6%

Now, deposits are increased by the loans that borrowers return which are nothing but the excess reserves.

So, New deposits = Reserves / Reserve requirement = $36 million / 6% = $600 million

New balance sheets after effect of reserve requirement change -

b) Reserves = 10% x $450 million = $45 million

balance sheets before effect of reserve requirement change -

balance sheets after effect of reserve requirement change -

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