Question

# Assume that Deposits are 1000, the reserve requirement is 0.1. The bank currently has 500 in...

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?

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

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