Question

You deposit $3,000 in currency into your checking account at Elmo's Bank, which has no excess reserves. The required reserve ratio is 20%.

a. Use a T-account to show the initial effect of this transaction on Elmo's Bank balance sheet.

b. Suppose Elmo's Bank makes the maximum loan it can from the funds you deposited. Use a T-account to show the initial effect of granting the loan on Elmo's Bank balance sheet.

c. What is the maximum increase in checking account deposits that can result from your deposit? What is the maximum increase in the money supply? Briefly explain.

Answer 1

Part A

	Elmo's Bank
Assets		Liabilities
Reserves	+$3000	Deposits	+$3000

Part B

	Elmo's Bank
Assets		liabilities
Reserves	+$3000	Deposits	$+3000
Loans	+$2400	Deposits	$+2400

Deposit = 3000-(3000*20% reserve ratio) =2400

Part C

maximum increase in checking account deposits = deposit * 1/reserve ratio = 3000*1/0.20 = $15000

maximum increase in the money supply= maximum increase in checking account deposits - original deposit = 15000-3000 = $12000

Maximum increase in checking account deposits and maximum increase in the money supply are not same as the cash is already considered in original money supply.