Question based on consolidated balance sheet

Question

Assume the simplified consolidated balance sheet illustrated below is for the whole chartered banking system. All of the figures are in billions. Desired reserve ratio =25 %.

a. What amount of excess reserves does the chartered banking system hold? Determine maximum amount the banking system might lend? Illustrate in column 1 how the consolidated balance sheet would appear after this amount has been lent. Determine the monetary multiplier?

b. Answer the questions in part a supposing that the reserve ratio is 20 %. Describe the resulting differentiation in the lending ability of the chartered banking system.

 

 

Answer 1

(a) Desired reserves is $50 billion (= 25% of $200 billion); thus excess reserves will be $2 billion (= $52 billion - $50 billion).  Maximum amount that banking system can lend is $8 billion (= 1/.25 - $2 billion).  Column (1) of Assets data =$52 billion; $48 billion; $108 billion.  Column (1) of Liabilities data= $208 billion.  Monetary multiplier is 4 (= 1/.25).

(b) Desired reserves = $40 billion (= 20% of $200 billion); thus excess reserves = $12 billion (= $52 billion - $40 billion).  Maximum amount banking system can lend = $60 billion (= 1/.20 - $12 billion).  Column (1) data for assets after loans (top to bottom); $52 billion; $48 billion; $160 billion.  Column (1) data for liabilities after loans:  $260 billion.  Monetary multiplier = 5 (= 1/.20).  The decrease in the reserve ratio increases the banking system’s excess reserves from $2 billion to $12 billion and enhances the size of the monetary multiplier from 4 to 5.  Lending capacity becomes 5 - $12 = $60 billion.