Question 1. T- Accounts and the Money Multiplier
All Banks are required to hold $1 in reserves for e very $10 of deposits in this economy. Assume that a ll accounts were previously equal to 0 (or that we are only looking at changes), and that there are an infinite number of banks in this economy.
a) At first Susan has $3000 cash in hand. Suppose t hat she deposits all of these in Bank #1. Fill the following table for Bank #1 immediately after Susan has made her deposit. Be sure to label all entries.
Bank #1's Balance Sheet
Assets Liabilities
b) Because Susan deposits $3000 in cash in Bank #1, Bank #1 has
i. Total Reserves =
ii. Required Reserves =
iii. Excess Reserves =
c) Now suppose that Bank #1 lends out any excess re serves to Bill. Bill uses the entire loan to buy a TV from Best Buy, who deposits his payment in Bank #2. Fill in the following table for Bank #1 and #2 immediately after Best Buy has deposited his paymen t (Bill’s loan) in Bank #2. Be sure to label all entries.
Bank #1's Balance Sheet
Assets Liabilities
Bank #2's Balance Sheet
Assets Liabilities
d) Suppose that Bank #2 lends out all of its excess reserves to Fred, and Fred’s loan ends up being deposited in Bank #3. Fill in the following tables for bank #2 and bank #3
Bank #2's Balance Sheet
Assets Liabilities
Bank #3's Balance Sheet
Assets Liabilities
e) Suppose this lending cycle continues many times (infinity). Fill in the following table for All Ban ks Combined. (Assuming there are no currency drains.
Combined bank Balance Sheet
Assets Liabilities
f) Compared the scenario above to one in which Susa n hold the entire $3000 as cash. How much will the above cycle (started with Susan depositing all of the money into a bank) increase the money supply in our economy? (Assuming there are no currency dra ins.) What is the money multiplier?
g) Use the Combined Bank Balance Sheet we get from e), if Michael withdraws $100 to put in his wallet. (maybe just to avoid the situation that som e armed robbery happens to him but he doesn’t have enough money to give to the guy, and then the guy s hall be very angry at him, or maybe aliens...use your imagination) What will happen to the money sup ply in our economy? (Assuming there are no currency drains.)
Combined bank Balance Sheet
Assets Liabilities
Question 2. Open Market Operations Suppose the Federal Reserve bank buys back 1 million worth of government bonds in the market through an open market operation.
a) Assume that the required reserve rate for deposit is 10%. What is the effect on the money supply by this open market operation?
b) Assume that the required reserve rate for deposit is 20%. What is the effect on the money supply by this open market operation
c) Assume that the required reserve rate for deposit is 20%. But instead of buying bonds, the Fed decides to sell 1 million worth of government bonds . What is the effect on the money supply by this open market operation
Question #3 . Suppose that the Federal Reserve forecasts a recess ion in 2008 for our economy (i.e. the aggregate demand will be too low).
(a) To boost up our economy, should the Fed try to l ift up the interest rate or should it try to lower it?
(b) To achieve this goal, what open market operati on should the Fed do? Should they purchase bonds or should they sell bonds in the market?