The money supply expansion process
Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank all have zero excess reserves. The required reserve ratio is 20%. The Federal Reserve buys a government bond worth $750,000 from Shen, a client of First Main Street Bank. He deposits the money into his checking account at First Main Street Bank.
Complete the following table to reflect any changes in First Main Street Bank's balance sheet (before the bank makes any new loans).
Assets Liabilities
Net Worth $150,000 Reserves $750,000
Complete the following table to show the effect of a new deposit on excess and required reserves when the required reserve ratio is 20%.
Hint: If the change is negative, be sure to enter the value as a negative number.
Amount Deposited Change in Excess Reserves Change in Required Reserves
(Dollars) (Dollars) (Dollars)
750,000
Now, suppose First Main Street Bank loans out all of its new excess reserves to Poornima, who immediately writes a check for the full amount to Manuel. Manuel then immediately deposits the funds in his checking account at Second Republic Bank. Then Second Republic Bank lends out all of its new excess reserves to Shen, who writes a check to Valerie, who deposits the money in her account at Third Fidelity Bank. Finally, Third Fidelity lends out all of its new excess reserves to Caroline.
Fill in the following table to show the effect of this ongoing chain of events at each bank. Enter each answer to the nearest dollar.
Increase in Checkable Deposits Increase in Required Reserves Increase in Loans
(Dollars) (Dollars) (Dollars)
First Main Street Bank
Second Republic Bank
Third Fidelity Bank
Assume this process continues, with each successive loan deposited into a checking account and no banks keeping any excess reserves. Under these assumptions, the $750,000 injection into the money supply results in an overall increase of in checkable deposits.