Question

Using T-accounts please explain what happens to bank reserves and monetary base when a bank sells $10 million of bonds to the Fed to pay back $10 million on the loan it owes to the Fed? You will need to show the changes on two T-accounts, one for the Fed and another for the bank.

Answer 1

Here the effect of both transaction will be null.

Here Bank will close the the $10 million loan by issuing another $10 million of bonds. So no cash transaction will happen. Simply banks liability of Discount loans will reduced by $10 million and same amount of Liability of Bonds will increase.

Since the same transaction will happen in Feds Asset. Nothing will happen in liabilities(Cash).

So monetary base and bank reserves will be unchanged.

Bank :

Asset :
Reserve : 0

Liability :
Discount Loans : -$10 million
Bonds : + $10 million

Fed :
Asset :
Discount Loans : - $10 million
Bonds : + $10 million
Liabilities :
Cash : 0