Thursday 25 March

 

1. Suppose a bank with no excess reserves receives a deposit of $100,000 into a checking account, and then has $80,000 worth of excess reserves. What is the required reserve ratio?

a. 10% b. 20% c. 80%

d. insufficient information to answer.

If it had no excess reserves before, but has $80,000 now, $100,000 minus $80,000 equals $20,000 must be required reserves, so the required reserve ratio is $20,000/$100,000 equals 20%, b.

2. The Fed buys $10 billion of bonds from the public (e.g. life insurance companies). What is the immediate effect on the money supply?

  1. Increase of $10 bn.
  2. Reduction of $10 bn.
  3. no change.

The Fed paid $10 billion [with, in effect, its IOU's -- either currency or a check drawn on itself; both are money], so the immediate effect is that the money supply increased by $10 bn., a.

3. Same as 2., if the required reserve ratio is 10%, what is the maximum effect on the money supply in the long run?

  1. Increase of $100 bn.
  2. Reduction of $100 bn.
  3. no change.

If the Fed paid with a check (most likely), the deposits with the Fed of the commercial bank through which the check was paid have gone up by $10 bn -- and those deposits with the Fed are the commercial bank's reserves. If the required reserve ratio is 10%, each $1 of reserves can support a maximum of $10 of commercial bank liabilities, i.e. checking account balances with commercial banks (which are money). So if the banking system makes the maximum possible loans, all loans are redeposited in checking accounts in commercial banks, and the banking system in the long run has no excess reserves, the money supply can expand by at most ten times $10 bn., i.e. $100 billion, a.