Question

If the Fed purchases $2 million of bonds from the First National Bank (FNB) and lends the discount loan of $1 million to the FNB bank and the depositors of the FNB withdraw $0.5 million and hold it as currency, what happens to the assets and liabilities of the Fed and the First National Bank and the monetary base? Use T-accounts to explain your answer.

Answer 1

Answer:

Fed's Balance sheet

Assets	$	Liabilities	$
Bonds	+2 Million
Loan to FNB	+1 Million

FNB's Balance sheet

Assets	$	Liabilities	$
Bonds	-2 Million	Loan from Fed	+1 Million
		Deposits	-0.5 Million

Monetary base= Currency+Reserves.

Currency increased by $0.5 Million but there is no change in reserves. So, Monetary base also increased by $0.5 Million.

Assets of Fed increased by $3 Million(as seen in the Balance sheet of Fed above). Assets of FNB decreased by $2 Million and liabilities of FNB increased by $0.5 Million(1 Million-0.5 Million).