Question

You are going to withdraw cash from your checking account. Illustrate how the transaction impacts the supply of money, the reserve bank, and the excess reserve at your bank. (Use a diagram and a written explanation).

Answer 1

Withdrawal of cash from bank will lower the value of checkable deposits, which decrease the bank's required reserves and decrease excess reserves (required reserve ratio remaining unchanged), therefore banks will be able to lend less money as credit. Lower credit lending will decrease money supply, which will increase interest rate and decrease quantity of money.

In following graph, MD0 and MS0 are initial money demand and money supply curves intersecting at point A with initial interest rate r0 and quantity of money M0. When money supply falls, MS0 shifts left to MS1, intersecting MD0 at point B with higher interest rate r1 and lower quantity of money M1.