Question

1. Assume Fred has $500 in cash and that this is the entire monetary base. Assume that the reserve requirement for banks is 5% and that reserves are taken on checking accounts but not money market accounts. a. What is the current level for M1 and M2? b. If Fred deposits the $500 into his checking account what happens to M1 and M2? . What are the required reserves? How much is the bank excess reserve ? c. The bank where Fred has a checking account would like to extend a loan to another customer, Sue. How large a loan can the bank extend? After the loan what happens to the Monetary Base, M1 and M2? If the bank deposits the proceeds of the loan into Sue’s checking account what are the required reserves of the bank? 5Q d. If both Fred and Sue want to withdraw their money at the same time this would cause a run on the bank. What options does the bank have?

I need answers with explanation ASAP

Answer 1

ANSWER:

1) Both M1 and M2 are $500.

2) Both M1 and M2 are unchanged at $500 .

required reserves = reserve requirement * deposit = 5% * $500 = $25

excess reserve = depsoit - required reserves = $500 - $25 = $475

3) The bank can lend $475 to sue and the monetary base will be unchanged at $500.

M1 = money that can be lend to sue + monetary base = $475 + $500 = $975

M2 = money that can be lend to sue + monetary base = $475 + $500 = $975

Required reserves = reserve requirement * (M1 or M2)

Required reserves = 5% * $975 = $48.75

4) The bank can borrow cash from another bank or it can borrow reserves from another bank through the fed funds market or the bank could simply borrow from federal reserve or the bank could sell the loan to another bank for cash and then the bank to whom loan has been sold can recall the loan from sue.