Question

Assume that the Empathy State Bank begins with this balance sheet and is fully loaned up. Use the information to answer the following questions.

Empathy State Bank

Assets		Liabilities
Vault cash	$    250	Deposits	$20,000
Deposits at the Federal Reserve	750
Loans	19,000

a. What are this bank's legal reserves?

b. What is the reserve requirement equal to?

c. If the bank receives a new deposit of $5,000 and the bank wants to remain fully loaned up, how much of this new deposit will the bank lend out?

d.When the new deposit to Empathy State Bank works itself through the entire banking system (assume all banks keep fully loaned up), how much new money may be created?

e.What is the potential money multiplier equal to in this case?

Answer 1

A. Legal reserve is the $750 which is deposited with the Fed

B. Reserve requirements or reserve ratio = reserve / deposits * 100 = 750/20,000 * 100 = 0.0375 * 100 = 3.75%

C. 3.75% of the new deposit needs to be deposited to the Fed as a legal reserve and the rest can be loaned out. The required reserve = 3.75% of 5,000 = 3.75/100 * 5,000 = 187.5.

So, the bank will lend out 5,000 - 187.5 = $4812.5

D. New money creation depends on the money multiplier. Money multiplier = 1/reserve ratio = 1/3.75% = 1/0.0375 = 26.67

So, the new money created = $5,000 * money multiplier = $5,000 * 26.67 = $133,350

E. Potential Money multiplier = 1/reserve ratio = 1/3.75% = 1/0.0375 = 26.67​