Question

Suppose that you deposit $2000 in currency into your checking account at the branch of a bank, which is assumed to have no excess reserves at the time you make your deposit. Also assume that the reserve requirement ratio is 20%.

a) Show the initial impact of this transaction on the bank’s T-account:

b) Suppose the bank makes the maximum loan it can from the funds you deposited. How does the T-account change?

c) What is the maximum increase in checking account deposits that can result from your $2000 deposit? What is the maximum increase in the money supply?

Answer 1

(a)

Assets	$	Liabilities & Capital	$
Required Reserves	400	Deposits	2,000
Excess reserves	1,600

(b)

After loans equal to excess reserves are made:

Assets	$	Liabilities and capital	$
Required (Total) reserves	400	Deposits	2,000
Loans	1,600

(c)

Maximum increase in deposits ($) = [(Initial deposit / Reserve ratio)] - Initial deposit = (2,000/0.2) - 2,000 = 10,000 - 2,000

= 8,000

Maximum increase in money supply ($) = Initial deposit / Reserve ratio = 2,000/0.2 = 10,000