Spartan Town Bank is the only bank in town when it comes to borrowing or depositing. You may also assume it’s the only bank in the economy. Initially, it holds $4000 worth of checking (or demand) deposits, $1000 of reserves, and $3000 of loans. The reserve requirement is 20%. [General Hint: M1 = Total Deposits + Cash. Anytime you are asked for the “maximum amount of M1,” you should think in terms of the greatest amount of checking deposits that can supported by the total stock of bank reserves. Combine that amount of checking deposits with the amount of currency in the public's hands, and you have M1 or the money supply]
a. Construct a T-account for Spartan Town Bank. What is the bank’s current reserve ratio? What is the bank’s current excess reserve ratio? What evidence do you have that this Town Bank has already engaged in fractional reserve banking?
b. Happy Jack, the town crier, holds the only currency held by the public in the economy. This currency amounts to $500, which he keeps in his wallet. What is the size of the monetary base M0 in the economy? M0 = (cash held by the public) + reserves. What is the size of the M1 money supply in the economy?
c. How large are the excess reserves of Spartan Town Bank? Assuming Happy Jack keeps his $500 in his wallet, what is the maximum amount of M1 that could exist, assuming no change in Fed policy?
d. Assume again that the bank’s balance sheet is as stated in the beginning of the question. Happy Jack INSTEAD decides to deposit his $500 in the bank. Show the bank’s new balance sheet after this deposit but before it makes any new loans. Now what is the maximum M1 that could exist, given no change in Fed policy?