Question

a.  If bank A borrows $10 million from bank B, what happens to the reserves in bank A? In the banking system? Please explain.

b. If bank A borrows $10 million from the Fed, what happens to the reserves in bank A?. In the banking system? Please explain.

c. Assume GDP is currently $14,000 billion per year and the quantity of money is $1,750 billion. What is the velocity of money? The nation collectively holds enough money to finance how many days worth of GDP expenditure?

Answer 1

a.When a bank borrows moneyfrom the fed then money supply increases in the economy as its reserves increases while the reserves of no other bank decreases.

If bank A borrows from bank B then it will pay federal fund rates (0.36%) to bank B. Reserves will increase by 10 million - (.36% of 10 million) = $6.4 million

b.If bank A borrows $10 million from the Fed then it will pay discount rate (1%) to the fed and reserves will increase by $10 million - (1% 0f 10 million) = $9.9 million.