Question

Consider a new deposit to the US banking system of $1000. Suppose that all banks have a desired reserve ratio of 20%. The following table shows how deposits, reserves, and loans enable the creation of money. Assume there is no currency drain and that banks do not hold on to excess reserves.

A. Complete the table below

Round	Change in Deposits	Change in Reserves	Change in Loans
1	$1000	$200	$800
2
3
4
5

B. After 5 rounds, what is the total change in deposits as a result of the single NEW deposit?

C. What is the eventual total change in deposits?

D. What is the eventual change in the money supply?

E. What is the eventual change in reserves? In loans?

F. Assume that the Fed implements a new law that sets a required reserve ratio equal to 30%. How would this have changed your answers to the parts (c) and (d).

Answer 1

	Round	Change in Deposits	Change in Reserves	Change in Loans
	1	$1,000	$200.0	$800.0
	2	$800	$160.0	$640.0
	3	$640	$128.0	$512.0
	4	$512	$102.4	$409.6
	5	$410	$81.9	$327.7
	Total Change in Deposits = 1/0.20*1000			$5,000.0
	Change in Money Supply			$5,000.0
	Change in Reserves =1/0.8*1000			$1,250.0
	Change in Loans			$5,000.0
	If Reserve Rate Changes to 30%
	Round	Change in Deposits	Change in Reserves	Change in Loans
	1	$1,000	$300.0	$700.0
	2	$700	$210.0	$490.0
	3	$490	$147.0	$343.0
	4	$343	$102.9	$240.1
	5	$240	$72.0	$168.1
	Total Change in Deposits = 1/0.30*1000			$3,333.3
	Change in Money Supply			$3,333.3
	Change in Reserves =1/0.8*1000			$1,428.6
	Change in Loans			$3,333.3