Question

Assume that Deposits are 1000, the reserve requirement is 0.1. The bank currently has 500 in total reserves, and a desired excess reserve ratio of 0.05. Assume c=0. How many new loans can the bank issue? What will be the change in the Money Supply?

Answer 1

Question

Deposits = 1,000

Reserve requirement = 0.1

Required reserves = 1,000 * 0.1 = 100

The required reserves of bank is 100.

Desired excess reserve ratio = 0.05

Desired excess reserves = 1,000 * 0.05 = 50

The desired excess reserves of bank is 50.

Calculate the reserves that can be utilized for making loans -

Reserves = Total reserves - Required reserves - Desired excess reserves

Reserves = 500 - 100 - 50 = 350

The reserves that can be utilized for making loans 350.

So,

The new loans bank can issue is 350.

Calculate the money multiplier -

Money multiplier = 1/(reserve ratio + desired reserves ratio) = 1/(0.1+0.05) = 1/0.15 = 6.67

The money multiplier is 6.67

Calculate the change in money supply -

Change in money supply = New loans issued by bank * Money multipier = 350 * 6.67 = 2,334.5

The money supply will increase by 2,334.5