Question

The reserve ratio is 10 percent. After the Fed buys $1 million in U.S. government securities from a bond dealer by transmitting the funds to the dealer's deposit account at Bank A, Bank A lends a construction company an amount equal to its excess reserves. The construction company spends the entire amount on lumber from a lumber yard, which deposits the construction company's check in its deposit account with Bank A. The maximum loan Bank A can now make is

A.$100,000.

B.$900,000.

C.$810,000.

D. $1 million.

Answer 1

Ans: C) $810,000

Explanation:

In the first transaction ;

Required reserve amount = 10% or $1,000,000 = $100,000

Excess reserve = $1,000,000 - $100,000 = $900,000

Now the Bank A lends a construction company an amount equal to its excess reserves that is $900,000.

In the second transaction;

The construction company spends the entire amount on lumber from a lumber yard, which deposits the construction company's check in its deposit account with Bank A.

Required reserve amount = 10% or $900,000 = $90,000

Excess reserve = $900,000 - $90,000 = $810,000

The maximum loan Bank A can now make is $810,000