Question: 1. Assume Country Cinderella is having a fractional banking system. The First National Bank acquires $600,000 in new deposits and initially uses part of this to make new loans of $400,000. The T-account of First National Bank, showing changes in its assets and liabilities, is as follows:
Assets Liabilities
Change in Reserves $200,000
Change in Loans $400,000 Change in Deposits $600,000
a) Assume that the Central Bank of Country Cinderella asks its banks to hold 10% of deposits as reserves. How much excess reserves does First National Bank hold?
b) Assume that all other banks hold only the required amount of reserves and that the public holds no cash. If First National Bank decides to reduce its reserves to only the required amount, by how much will the economy's money supply increase?